Year in review

2015 proved a tough year for investors worldwide. All asset classes suffered declines with almost no place to hide. Bonds were affected by the expectation for the hike in US interest rates which the Fed finally announced on December 16. Equity in most developed markets were weak on the backdrop of both demanding valuations and a relatively weak global economy suffering from the challenging financial situation of China. 

Fortunately, the way we positioned our portfolios proved quite prescient; we were able to largely walk between the raindrops as all our client portfolios ended 2015 in the black. Our assessment for the year was that bonds offered minimal yields and were exposed to the risk of an increase in interest rate or inflation. We also considered that equities trading at fair values did not offer a particularly compelling value proposition in view of the risks related to the interest rates and the global economy. Our conclusion was that good alternative investments with limited market correlation represented the best approach for 2015.

We underscore the qualificative “good” alternative investments because in an alternative universe that includes more than 10’000 hedge funds the ability to identify and select the very best providers is key. This is evidenced by the fact the hedge fund industry as a whole lost 3.5% according to the HFR Global Hedge index. On the other side, we were pleased by the results of the hedge funds in our portfolios as the vast majority of them were up significantly including solid double-digits returns for this year’s top performers. Importantly, most of these funds are highly conservative and have achieved these results with a very limited level of risk. 

The other area of opportunity we identified is the field of alternative finance where we are looking for financial players with a unique expertise in an investment niche with limited correlation to the financial markets. Our investments in this field did not disappoint either. As an example, one of the alternative finance funds we are invested in generated a net return of over 5% by making loans to niche markets which the major UK banks scaled-down or exited due to the new Basel III capital adequacy regulations.

While the 5-7% nominal yields in High-Yield credit at the beginning of the year appealed to many we believed that it was not compensating investors adequately for the incurred risk. This assessment was proven right towards the end of the year when energy companies which represent a sizeable part of high-yield issuers got into trouble due to the depressed energy prices which led to significant losses for high-yield investors. Earlier in the year Marketwatch wrote that: “Many financial advisers have stuffed high-yield bonds into client portfolios with high-yield funds. Individual investors should check their portfolios for these funds, and also for multi-sector bond funds that typically always own a slug of junk bonds among other kinds of bonds”.1 Thankfully we recognized these risks and had minimal exposure to the asset class. We will keep following the developments in the high-yield market as we do for all asset classes but do not see the current valuations as cheap enough yet to be attractive.

Clearly commodities were the worst performer of 2015 driven by the weakness of the Chinese economy and the end of the commodity super-cycle. In retrospect we certainly wish we would have reduced the weight of commodities and gold to 0% in all portfolios although the adverse impact was limited by the fact that the allocations were very small and for diversification purpose only.

An investing area we appreciate much and will continue to expand is private equity. While its illiquid nature limits its weight in any portfolio it represents an outstanding way to diversify the portfolio and add a source of upside which should be significant and largely uncorrelated to financial markets. Our investments in the field include healthcare startups who performed nicely. Going forward the valuations of these companies will be primarily influenced by their ability to successfully develop new drugs rather than by the fluctuations of global financial markets.

In terms of currencies, the dollar strengthened markedly as we had expected. We believe that the dollar appreciation cycle is not over yet and that the USD will continue to appreciate against most currencies in 2016 albeit probably in a more moderate manner.

Outlook for 2016

Our outlook for 2016 is almost the same as it was for 2015. Equities in most markets, bonds and the majority of asset classes remain exposed to the adverse mix of elevated valuations and appreciable macroeconomic risks. While we will be considering certain pinpointed additional investments such as possibly European equities or Brazilian bonds, increasing the allocation to the main asset classes would only become potentially compelling after a significant correction and we will update our views as the year goes on.

As a consequence, we recommend a strong focus on alternative investments, alternative finance and, to a more limited extent, private equity.

 

Market returns in 2015, by asset class (in percents %)

 

(1) http://www.marketwatch.com/story/yield-hungry-investors-are-greedy-so-you-should-be-fearful-2015-05-11

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