Year of the Comeback? Portfolio Diversifiers Rally in first half of 2016

August 16, 2016 Categories: Portfolio Corner
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In a certain sense, it has been easy to make money in the capital markets over the last few years. For many U.S. investors, the winning approach has been “The simpler, the better.” In many cases, an allocation to some mix of U.S. stocks and bonds has done better than more diversified portfolios targeting a similar level of risk.

Indeed, for many of those investors who lean towards global diversification, it has been a challenging time. Those asset segments that are typically added to a mix of U.S. stocks and bonds either to enhance return potential or decrease overall portfolio volatility – such as high yield, emerging market equities, global infrastructure and commodities – have broadly failed to accomplish either of those tasks. The chart below shows how these “diversifiers” fared in 2015. On the face of it, not a pretty picture.

2015 calendar year returns

U.S. Stocks: Russell 3000® Index; U.S. Bonds: Barclays U.S. Aggregate Bond Index; High Yield: BoAML Global High Yield Index; EM Equities: MSCI Emerging Markets Index; Global Infrastructure: S&P Global Infrastructure Index; Commodities: Bloomberg Commodities Index

In contrast, the first half of 2016 has been a welcome reprieve – and boost of confidence – for many of those investors who maintained their broad diversification discipline. Many of these asset segments have produced strong results against a backdrop of volatile equity markets.

2016 YTD Returns

U.S. Stocks: Russell 3000 Index; U.S. Bonds: Barclays Aggregate Bond Index; High Yield: BoA Merrill Lynch Global High Yield Index; EM Equities: MSCI Emerging Markets Index; Glbl Infrastructure: S&P Global Infrastructure Index; Commodities: Bloomberg Commodities Index

This sense of relief is particularly strong for those who invested in commodities – which have had a rough ride over the past five years. Not only did commodities (Bloomberg Commodities Index) drop almost -25% in 2015, but for the five years ending December 2015 commodities lost -13.5% per year. Much of that disappointing performance is due to the drop in energy prices as oil prices went from a high of $140 a barrel in 2008 to a recent low of below $30 per barrel in February 2016.

That said, not all commodities fared as poorly as oil, though admittedly energy tends to be the highest profile sector amongst the commodity markets. As the chart demonstrates below, commodities is made up of much more than just energy/oil.

YTD through 6/30/2016. Bloomberg Commodity Index Total Return sectos. Energy: Natural Gas, WTI Crude Oil, Brent Crude Oil, Unleaded Gasoline, Heating Oil; Industrial Metals: Copper, Aluminum, Zinc, Nickel; Precious Metals: Gold, Silver; Grains: Corn, Soybeans, Wheat, Soybean Oil, Soy Meal, Kansas Wheat; Softs: Sugar, Coffee, Cotton; Livestock: Live Cattle, Lean Hogs. Indexes are unmanaged and cannot be invested in direction. Returns represent past performance, are not guarantee of future performance, and are not indicative of any specific investment.

YTD through 6/30/2016.
Bloomberg Commodity Index Total Return sectors. Energy: Natural Gas, WTI Crude Oil, Brent Crude Oil, Unleaded Gasoline, Heating Oil; Industrial Metals: Copper, Aluminum, Zinc, Nickel; Precious Metals: Gold, Silver; Grains: Corn, Soybeans, Wheat, Soybean Oil, Soy Meal, Kansas Wheat; Softs: Sugar, Coffee, Cotton; Livestock: Live Cattle, Lean Hogs.
Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not guarantee of future performance, and are not indicative of any specific investment.

As the chart above shows, the individual commodities sectors have posted a wide range of results and a great deal of diversification amongst each other. Which is a good reason that commodities tend to act as a good diversifier for the other assets in an investment portfolio as well. The last few years have been difficult from a return perspective, but commodities tend to run in cycles and this year’s strong start may be the beginning of a new, more positive cycle for the asset class. Even if not, it is very likely to expect that they will still deliver diversification benefits to the rest of the portfolio.

The Bottom Line

It can be very difficult to stick with an investment that “hasn’t been working,” especially when it is thought of more as a “diversifier” than the “foundation” of a portfolio. However, before abandoning any investment it’s best to revisit the reason for holding it and reassess its potential impact on the portfolio in the future. We believe that the favorable performance reversal of diversifiers in the first half of 2016 is a good example of that.

Disclosures:

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.

The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Bond investors should carefully consider risks such as interest rate, credit, default and duration risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield (“junk”) bonds or mortgage-backed securities, especially mortgage-backed securities with exposure to sub-prime mortgages. Generally, when interest rates rise, prices of fixed income securities fall. Interest rates in the United States are at, or near, historic lows, which may increase exposure to risks associated with rising rates. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries.

Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems, which can be expected to have less stability than those of more developed countries. Securities may be less liquid and more volatile than US and longer-established non-US markets.

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.

Russell 3000® Index: Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. (specifically: Barclays Government/Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).

BofA Merrill Lynch Global High Yield Index: Tracks the performance of USD, CAD, GBP and EUR denominated below investment grade corporate debt publicly issued in the major domestic or Eurobond markets.

MSCI Emerging Markets Index: A float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

The S&P Global Infrastructure Index: Provides liquid and tradable exposure to 75 companies from around the world that represent the listed infrastructure universe. To create diversified exposure across the global listed infrastructure market, the index has balanced weights across three distinct infrastructure clusters: Utilities, Transportation, and Energy.

Bloomberg Commodity Index Total Return: Composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as “rolling” a futures position.

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.

The Russell logo is a trademark and service mark of Russell Investments.

Copyright © Russell Investments 2016. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

Russell Investments Financial Services, LLC, member FINRA (www.finra.org), part of Russell Investments.

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