A Most Challenging Year

2016 was off to a rocky start when trading opened on January 4, and that only served to sharpen the sense that investing will continue to face the pervasive challenges of the year before. A bad start to the year, of course, is not nearly the harbinger that too many hyperbolic news outlets would have us believe, but it does offer an opportunity to assess the past year with an eye toward what might lie ahead.

Without a doubt, 2015 was a difficult year for investing. Not difficult as in catastrophically or dramatically bad, such as 2008 and early 2009, or 2002. But unlike prior years, 2015 offered very few opportunities for positive returns in any asset class, especially liquid, traded assets.

According to analysis done by Societe´ Generale, 2015 was the hardest year to generate returns since 1937. In the 78 years since then, at least one asset class tended to boast returns of 10%. Another study found that a quarter of the time, there was one asset class that had returns of at least 30%, even if other assets were down by double digits.

In 2015, however, none of that pertained. Of the major stock indices in the United States, only the Nasdaq had a decently positive year, with greater than 5% returns. Everything else either was flat or down. The global picture was similar: developed markets were down about 3.5%, as measured by the MSCI EAFE, while emerging markets were down a whopping 18%. A few outliers posted positive returns: Japan (up more than 9%), New Zealand (up 13%), and China’s Shanghai exchange (up more than 9%). Some European exchanges were up as well, with Germany and France generating about 6% and 9%, respectively.

Bonds did not offer much as an alternative asset class.  Yields barely budged year over year in the United States, despite bouts of volatility as investors attempted to game when the Federal Reserve would at last raise rates (which it did by 25 basis points in its final meeting in December). US bond indices were down more than 1%, with many sub-categories, such as high-yield, down as much as 5%. Global bonds were considerably worse, ranging from emerging market bonds indices, down double digits, to developed markets sovereign and corporate bonds, down 5% to 10%.

And alternative asset classes, from hedge funds to commodities to precious metals, did nothing either: many hedge funds dropped by double digits as managers took on outsized bets in an attempt to generate outsized returns. The commodity and energy complex continued a massive price reset that resembled a slow-motion collapse as demand from China shrank rapidly, and too much supply came on line at precisely the same time. Even gold, the asset of choice for those with a defensive mindset who see great trouble in the world, performed quite poorly, declining more than 10%.

But in some respects, the picture was even worse than the tepid landscape charted above. Yes, the Nasdaq did well, but did so largely on the strength of a few stellar names such as Google/Alphabet, Amazon, Microsoft, Facebook, and Netflix. If you removed those, both the Nasdaq and the S&P 500 would have posted unequivocally negative returns for the year.

But if by chance you had been an asset allocator, a stellar portfolio that might have returned 10% or more was possible. It would have required crafting a portfolio composed predominantly of those five stock names, plus a significant exposure to Japan, Germany, New Zealand and France, and either avoiding emerging markets or shorting them. It also had to avoid global bonds and most US names as well, and steered clear of any commodity names (or shorted crude oil). And it needed to add some exposure to U.S.-listed real estate investment trusts (REITs).

It is safe to say, however, that almost no one (and in fact perhaps no one) had such an asset allocation strategy. That leaves the rest of the investing universe. Yes, some endowments and institutional investors can go further afield into private equity, venture capital, and direct investment in land and esoteric assets, such as timber. Some evidence suggests that private equity returns have surpassed those of publicly traded assets of late, along with select real estate deals in hot urban markets. But such investments are beyond the reach of the vast majority of investors, and hence offer, at best, a glimpse through the glass window: gaudy, but unobtainable. Even so, those investments are not the general case—deals have become ever pricier, sustained by higher levels of debt, and offer uncertain long-term prospects.

The net result is that 2015 was an astonishingly difficult year to make money for investors in almost every asset class. For asset allocators, who attempt to generate above-average returns by shifting the mix of equity, bonds, and alternatives, it was a year in which no asset class provided much in the way of ballast. Nearly everything was either flat, down, or down even more, and only the most astute (and lucky) tactical managers took advantage of technical signals to shift from cash to bonds to stocks at the right times. If you were a tactical strategist, who turned heavily to cash and away from equities over the summer, and then jumped right back into stocks in September, you were rewarded. But many of the managers who got that right in 2015 (and there were very few) did not exhibit the same acumen in 2014, 2013, or in prior years, raising the question of whether such perfect timing was a product of deep skill or shallow luck.

The year overall was hardly a disaster, but it was a poor year for almost everyone. For active allocators, it often was somewhat worse than the indices and benchmarks. Dynamic and tactical managers, like active fund managers, attempt to generate returns by, well, taking active positions distinct from strategic and static models. In some years, doing so yields returns above the norm; in 2015, for the most part, it yielded returns below the benchmarks.

It’s often said that the past is prologue. While that is always strictly true, what happened last year does not offer much in the way of guidance about what 2016 holds. Already, a slew of pundits predict that 2016 will offer more of the same for returns, with a distinct chorus suggesting that positive returns will be even harder to find. Human nature being what it is, people often predict a continuation of what has just happened; human history being what it is, that is often quite wrong.

What 2015 does show is that in a world of globalized investing, finding real outliers is ever more challenging, and distinctive theses may take some time to play out. Emerging markets, high-yield, one country’s equities versus another’s may be themes that mature over several years rather than one calendar year, even as the time frame to assess performance shrinks from annually to quarterly to monthly. So advisors and managers risk not only whipsaw performance, but also may be playing constant and futile catch-up if they take part in that game.

2015 may have been tepid, and 2016 may be as well, but that doesn’t mean that throwing in the towel and going to cash or going purely passive makes the most sense. Returns may be static, but the world most certainly is not. That is why continued attention to what is working, what is not, and what might be is the only way forward.


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