Insider

Heritage Investment Review: Q3 2016

In our last Market and Investment Review we demonstrated how a long-term investor, who sticks to his or her plan, and doesn’t get worked up by the financial media, tends to enjoy a superior investment experience. As we approach a once-in-four-year event—the election of a U.S. president—emotions tend to pique. We understand important questions are at hand. We would never presume to invalidate an individual’s feelings on the effect of the outcome of the election. However, like oil and water, emotions and investing rarely mix into a desirable solution. Long-term investors tend to continue an upward climb regardless of the president’s party (unless his name is Hoover).


In financial markets, expected future cash flows of stocks and bonds are discounted to arrive at prices. It’s important to recognize that in the absence of major economic revisions, the passage of time itself is on the investor’s side. All else equal, as time passes, cash inflows from stocks and bonds are realized or become closer to being realized. The effect is a positive return.

The third quarter of 2016 reinforced this point—it’s good to be invested when there aren’t dramatic changes in economic activity. In 2015 we summarized how it was a poor environment to generate returns by allocating between stocks, bonds and cash. Through the third quarter of 2016, being fully invested (not holding cash) had an important positive impact.

Global equity markets were led by emerging markets, which were up 16.02% over the first three quarters of the year. The United States equity market was up a healthy 8.18% and developed international equity
markets were up 1.73%. Heritage clients’ portfolios are positioned significantly overweight in emerging markets and significantly underweight in developed international markets. This global positioning led to material outperformance.

On top of the benefit from your global asset allocation, Dimensional Fund Advisors (DFA), Heritage’s primary equity manager, added further to return. The funds managed by DFA that Heritage selects to use significantly outperformed equity market benchmarks across the globe. DFA returned 8.94% in U.S. equities, 0.76% above its benchmark; 4.21% in developed international markets, 2.48% above its benchmark; and 20% in emerging markets, 3.98% above its benchmark.

We endeavor to deviate from stock-bond benchmarks by taking a number of calculated risks. Although our positioning in alternative investments relative to traditional assets did not directly add value during the first three quarters of 2016, it performed particularly well when equities were down at the beginning of the year, indirectly adding value by allowing us to rebalance to higher equity targets.

It’s also worth mentioning that the alternatives allocation has tamped volatility from shocks to traditional assets, notably during the equity market sell off at the beginning of 2016 and immediately after the “Brexit” vote. And the alternatives allocation has added significant value over the past few years. In 2015, Heritage’s alternative allocations returned 6.03%. In 2014, Heritage’s sub-strategies, reinsurance, managed futures and style premia were up 11.00%, 26.30%, and 11.03%, respectively. We consistently monitor our positioning and adjust as the relative opportunity set evolves.

The Barclays U.S. Aggregate Bond index increased 6.66% over the first three quarters of 2016. The majority of return in U.S. bonds came from price appreciation, as compared to interest income. In the third quarter, yields increased as the labor market continued to operate under the long-term natural rate of unemployment and the impact of higher commodity prices started to feed into the price level. Inflation is now increasing at an annual pace of over 2% per annum. All the way through the 20-year term, interest rates are below the Fed’s target and current pace of inflation.

We remain resolute that long-term bonds are a poor investment at current yields. Our clients’ U.S. bond portfolio is positioned to outperform the Barclays U.S. Aggregate Bond index if the yield curve doesn’t change or if interest rates rise. Our clients will likely underperform if rates move lower, but will still achieve acceptable absolute returns. We are willing to accept lower upside if interest rates decline for lower downside if interest rates increase.

Thank you for allowing us to be stewards of your wealth through an ever-changing financial environment. We believe you are well positioned to continue to reach the return objectives in your financial plans. We will continue to evaluate the relative value of major asset classes and explore the prudence of new asset classes or strategies that will maintain the resiliency of your portfolio across multiple scenarios.

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