HELPING INVESTORS Consider this - Russell Investments · 2016-10-12 · Russell Investments // Helping investors // Consider this From the author Continued uncertainty in the financial

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Consider thisHELPING INVESTORS

JULY 2016

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The challenges of investing with a rearview mirror by Frank Pape, Director, Consulting Services

Russell Investments // Helping investors // Consider this

From the authorContinued uncertainty in the financial markets made the past quarter and year to date challenging for most investors. The United Kingdom’s decision to leave the European Union, divergent global economic growth trends, the U.S. equity market’s recent past performance, and the upcoming presidential election have been unable to provide much insight into how markets will perform. In this scenario, many investors are wondering what to consider in their approach and if diversification is even helping?

In this edition, I explore these key issues facing investors at large, and provide a perspective based on facts available to date.

Frank Pape Director, Consulting Services


Challenges of investing through the rearview mirror“How come my diversified portfolio is not keeping up with the market?” This is a common question we have heard the last few months from investors. Considering that many investors perceive the “market” as the Dow Jones Industrial Average (DJIA) or the S&P 500 Index®, the concern is understandable. Both of these indexes have outperformed all other major asset classes coming out of 2008, including international stocks, global Real Estate Investment Trusts (REITs), U.S. bonds, and commodities.1

However, while both the DJIA and the S&P 500 can be acceptable proxies for U.S. stocks, they are just that. They only represent U.S. stocks and generally only the bigger U.S. stocks. In fact, the DJIA only represents the return of 30 U.S. stocks selected by Dow Jones and the S&P 500 is limited to U.S. stocks with index membership decided by committee.

At Russell Investments, we consider the “market” to be much more than big U.S. stocks. We believe in asset allocation that diversifies across asset classes such as international stocks, emerging market stocks, REITs, U.S. bonds, commodities and more.

We also believe the trend of U.S. stocks trumping all other major asset classes will reverse — just as it has at various points in the past. As the chart below shows, no single asset class has consistently beaten all the others over a 10-year time frame — there’s a different winner each decade.

Market leadership through time (January 1970 – April 2016)

U.S. Equity: Russell 3000® Index, 1979 to Present and S&P 500® Index prior; Non-U.S. Equity: MSCI EAFE Index; U.S. Bonds: Barclays U.S. Aggregate Bond Index; REITs: FTSE NAREIT Equity Index; Commodities: Bloomberg Commodity Index, 1991 to Present and S&P Goldman Sachs Commodity Index Prior; 50/50 Diversified: 30% U.S. Equity, 15% Non-U.S. Equity, 45% U.S. Bonds, 5% REITs, and 5% Commodities.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

1970’s 1980’s 1990’s 2000’s 2010- April 2016

Commodities 21.2%

Non-U.S. Equity 22.8%

U.S. Equity 17.7%

REITS 10.6%

REITS 14.3%

REITS 11.1%

U.S. Equity 16.6%

50/50 DIversified

10.9%

Commodities 7.1%

U.S. Equity 12.5%


50/50 DIversified

15.8%

REITS 9.1%

U.S. Bonds6.3%

50/50 DIversified

6.6%

50/50 DIversified

8.5%

REITS 15.6%

U.S. Bonds7.7%

50/50 DIversified

4.4%

U.S. Bonds4.1%

U.S. Bonds 6.6%

U.S. Bonds 12.4%




U.S. Equity 6.4%

Commodities 10.7%

Commodities 5.6%

U.S. Equity -0.2%

Commodities -7.3%

1 As of April 31, 2016


The challenge investors are faced with is virtually impossible to know in advance which asset class will do best. If you base your investment decision today on which asset class performed best in the prior 10 years, odds are regret will set in 10 years later.

Although diversification does not assure a profit or protect against loss, we consider diversification to be the closest thing to a “free lunch” that the market has to offer. And absent an email from Janet Yellen or Warren Buffet giving the all clear sign on when to favor specific asset classes, it seems that diversification remains a compelling response to market uncertainty.

We encourage you to take a longer-term perspective and to be cautious about allowing past performance drive your investment choices. After all, by looking in the rearview mirror, you may be tempted to second-guess that

“free lunch” of diversification that we believe can help you reach your long-term financial goals.

ELECTIONS AND INVESTMENT RETURNS

The upcoming election cycle is on nearly everyone’s mind at the moment. Many are asking what the election might mean to their investment portfolios. We know that writing about politics can be a sensitive topic. In fact, four years ago, we published an exhibit that showed the growth of the U.S. stock market from the 1950’s through 2011. We also overlaid who was president during that time with red and blue shading for political party affiliation. Needless to say, we received many comments about our biased reporting—from both sides of the political aisle. It reminded me of the quote from the late Senator Patrick Daniel Moynihan, “Everyone is entitled to his own opinion, but not his own facts.”

More recently, we looked at U.S. stock returns since 1945 matched up with political parties in control to see what insights may be drawn based on which party controlled the presidency and the composition of the Senate and House.

The exhibit below displays what the annualized U.S. stock market returns were during Democratic and Republican President terms since 1945. It also shows the returns depending on which combination of parties controlled the White House, the Senate, and the House of Representatives. The number of years we’ve had with each of the party combinations is shown in parenthesis.

It turns out that markets tend to perform in line with historical averages regardless of the political process – and it’s very challenging to determine the portion of return driven by political versus economic factors. For example, the worst-performing combination – Republican President, Democratic Senate and Republican House (RDR) – with an annualized return of -17%, occurred in 2001 and 2002. Arguably, these years reflected the aftermath of 9/11 and related recession.

Political leadership definitely matters, but investors need to consider much more than what political party was or will be in office. We know there will be market volatility leading up to the election and after the election. But we always have volatility.


-20% -15% -10% -5% 0% 5% 10% 15% 20%

RDR (2)

RDD (22)

Presidential Election Year (17)

Rep. President (36)

Average (71)

DDD (22)

RRR (4)

Dem. President (35)

DRR (9)

DDR (4)

RRD (8) 18.4%

16.3%

16.3%

15.2%

15.1%

14.5%

12.6%

10.6%

9.9%

8.5%

-7.0%

Annualized return

Number of years led by combination of parties

Just for fun, others have looked at physical traits of the President, such as height (the data favors those over 6-feet tall), eye color, dominant hand, etc.

In the end, it seems that that you should expect the average return. Again, we know these traits have no bearing on market returns, and reinforces how many factors go into market returns beyond just politics.

In the end, one can’t attribute 100% (or even 50%) of U.S. stock market returns solely to the political backdrop, as many factors go into market returns beyond just politics. And it seems that one should expect the average return.

Annualized U.S. stock returns (1945-2015)

U.S. Stocks: S&P 500 Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

RRD (8)= Republican President, Republican Senate, Democratic House occurred 8 years with average return of 18.4%

There is no doubt that political leadership matters, but investors need to consider much more than which party is in office when making decisions about their portfolio.


$91

$93

$95

$97

$99

$101

$103

$105

1/4/2016 2/4/2016 3/4/2016 4/4/2016

Growth of $100

PUTTING MARKET VOLATILITY INTO PERSPECTIVE

If an investor had hibernated from January 1, 2016 until April 29, 2016 they could be forgiven for assuming the markets had been relatively calm during that period. After all, U.S. stocks2 have returned 2% year-to-date as of April 29, 2016. But we know the path of that return has been anything but flat. Investors started out the year fleeing U.S. stocks with the market down 10% from the beginning of the year through February 11th. On February 12th, investors apparently did get the email from Janet Yellen or Warren Buffet for the all clear sign and markets generally moved up from there. Since February 11th, U.S. stocks are up 12% through April 29th. Combining these

“risk off” and “risk on” periods adds up to a seemingly flat return.

U.S. stock returns (January 1, 2016 - April 29, 2016)

U.S. Stocks: S&P 500


2 Represented by the S&P 500 Index

U.S. stocks pullback 10%(Jan 1st – Feb 11th)

U.S. stocks up 12%(Feb 12th – April 29th)


Although it’s certainly not pleasant in the moment, such a see-saw pattern of returns should not come as a surprise to investors. As the chart below shows, the U.S. stock market has experienced such volatility nearly every year since 1995. This chart shows the amount of pullback or negative return experienced during each year. For example, looking at January through April of 2016, you see the pullback of -10% with the year-to-date return of 2%. Consider the following observations:

› In 17 of the last 21 years, U.S. stock markets finished in positive territory

› The average annual pullback (peak-to-trough) was 15.2%

› When pullbacks were greater than 10%, 10 of those 14 years finished in positive territory

› There’s a pullback every year:

THE BOTTOM LINE Volatility should be expected as financial markets react to divergent global trends, and the political and economic changes. This is not the time to invest with a rearview mirror, and most investors may need to think beyond one asset class to maximize their returns.

U.S.stocks:: S&P 500® Index. Source: Morningstar. Returns calculated with dividends included. Maximum peak-to-trough represents the return difference between the largest peak-to-trough of the calendar year.


Calendar-year U.S. stock market returns (%) and intra-year declines

38

23

33

29

21

-9 -12

-22

29

11

5

16

5

-37

26

15

2

16

29

15

1 2

-3

-7 -11

-19

-12

-17

-29 -33

-14

-7 -7 -7 -10

-48

-27

-16 -19

-10 -6 -7

-12 -10

-60

-50

-40

-30

-20

-10

0

10

20

30

40

50

Cal

enda

r Y

ear

Ret

urn

(%

)

U.S. stocks Maximum peak-to-trough during the year


The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. No investment strategy can guarantee a profit or protect against a loss. These views are subject to change at any time based upon market or other conditions. Data stated is historical and not a guarantee of future results.Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets.Russell Investments is the owner of the trademarks, service marks, and copyrights related to its respective indexes.Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.› Index performance is not indicative of the performance of any specific investment. Indexes are not managed and may not be invested in directly.› Indexes are provided for general comparison purposes only.› Index return information is provided by vendors and although deemed reliable is not guaranteed by Russell Investments or its affiliates.Barclays U.S. Aggregate Bond Index A broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS.Bloomberg Commodity Index Family Represents the major commodity sectors within the broad index: Energy (including petroleum and natural gas), Petroleum (including crude oil, heating oil and unleaded gasoline), Precious Metals, Industrial Metals, Grains, Livestock, Softs, Agriculture and ExEnergy. Also available are individual commodity sub-indexes on the 19 components currently included in the DJ-UBSCSM, plus brent crude, cocoa, feeder cattle, gas oil, lead, orange juice, platinum, soybean meal and tin.Dow Jones Industrial Average A price-weighted average of 30 significant stocks traded on the New York Stock Exchange and NASDAQ.FTSE NAREIT all Equity Index Measures the performance of the commercial real estate space across the U.S. economy offering exposure to all investment and property sectors.MSCI EAFE (Europe, Australasia, Far East) Index A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.Russell 3000® Index Measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.The S&P 500® Index A free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. The stocks included in the S&P 500®are those of large publicly held companies that trade on either of the two largest American stock market exchanges: the New York Stock Exchange and the NASDAQ.Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.Russell Investments Financial Services, LLC, member FINRA, part of Russell Investments.Copyright ©2016 Russell Investments Group, LLC.First used July 2016 RIFiS 17432

› About Russell InvestmentsFor more than 40 years, we’ve helped guide the investments of some of the world’s largest companies, foundations and pension plans. Working with your financial advisor, you can benefit from this same expertise through our solutions that are strategically designed to address investors’ wide-ranging investment needs and objectives. No matter what stage of life you are in, we believe how you invest matters. That’s why we provide investment solutions that are designed with your goals in mind.

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HELPING INVESTORS Consider this - Russell Investments · 2016-10-12 · Russell Investments // Helping investors // Consider this From the author Continued uncertainty in the financial