In our quarterly investment update, we’d like to:
- Summarize market activity over the 2nd quarter of 2024
- Review the value of diversifying illiquid investments in a portfolio
- Provide various market returns information
Market Summary for the 2nd Quarter of 2024
In the 2nd quarter, the global stock market rally continued, with global stocks as represented by MSCI All Country World Index delivering a ~3% return, led by large growth companies in the US. After a sharp decline in 2022, US tech stocks represented by the Vanguard Information Technology ETF (source: Morningstar) have delivered a cumulative return of ~80% since the start of 2023. Emerging market stocks represented by the MSCI Emerging Market index also performed relatively well for the quarter, with a ~5% gain. The global stock market continues to be driven by optimism for future corporate earnings, and the US stock market remains at elevated prices relative to earnings. Foreign stocks remain close to their historical rate of prices relative to earnings.
The Bloomberg US Aggregate Bond index delivered a total return close to 0% for the quarter, as modest price declines offset interest income, due to a slight move up in rates marginally reducing bond prices. The 10-year US Treasury note, often used as a key measure of the bond market, ended the quarter with a yield of 4.36%, slightly up from 4.20% a quarter ago (source: Federal Reserve Bank of Saint Louis).
Major global economies continue to expand, including the US, Europe, Japan, Mexico, and India, as manufacturing activity improves across most markets. Business spending on capital projects increased as large companies scale their investments in artificial intelligence, and domestic manufacturing, which adds to US economic activity. Job creation and wage increases moderated, reflecting a slower pace of growth for the US labor market relative to recent years.
The Consumer Price Index for All Urban Consumers: All Items in U.S. City Average (CPI) at the end of the quarter reflected a ~3.0% rate of inflation over prices a year ago (Source: Federal Reserve Bank of Saint Louis), which represents a lower rate of inflation than has been experienced in the previous three years. While the rate of inflation on goods has substantially moderated, services and housing costs continue to experience persistently higher inflation rates. A reduction in inflation may provide justification for the Federal Reserve to reduce short-term interest rates, which would generally be expected to stimulate asset prices and economic activity.
The Value of Diversifying Illiquid Investments in a Portfolio
We would like to discuss the potential benefits of incorporating illiquid investments in client portfolios, starting with a brief description of what defines an illiquid investment, and then to explain why we include them in portfolios.
Illiquid investments are assets that cannot be quickly converted into cash without potentially incurring a loss in value. In contrast, stocks and bonds are highly liquid and can be quickly sold on a daily basis close to their market value. Unlike stocks or bonds, which can be easily bought or sold in public markets, illiquid investments require more time to convert to cash. Real estate is an example of an illiquid investment, as the process of finding a buyer, agreeing on a price, and executing a transaction can require a lengthy sales process. While a property could theoretically be sold in a day, the price would need to be below market value to incentivize a quick transaction.
We incorporate illiquid investments in client portfolios to achieve two primary purposes, diversification benefits and contributions to portfolio returns.
Diversification Benefits
To moderate swings in portfolio value, we seek to own investments that do not move in lockstep with other holdings, such as stocks and bonds. When investments move independently of each other, it can help to reduce the degree to which the portfolio declines in value when stocks or bonds experience a downturn.
An illiquid investment that we expect to operate independently of other investments is reinsurance, which is the business of providing insurance to insurance companies. We incorporate this type of investment through ownership of the Pioneer ILS Interval fund. Like other forms of insurance, income is generated by collecting insurance premiums, which are offset by claims paid out. The nature of this business tends to be quite independent of the stock and bond markets, and as a result can provide a diversification benefit.
One way to measure this benefit is through measuring correlation, which reflects the degree to which two assets move in relation to each other. Correlation is measured in a range of +1 (moving entirely in the same direction), to -1 (moving entirely in opposite directions), with 0 representing independent movements. The chart below shows the level of correlation for each labeled asset, with the height of each bar representing the degree of correlation to other assets. We can observe that the correlations for reinsurance are close to zero, while the other assets are moderate to highly correlated, with values of 0.3 to 0.8.
Data from 1/1/2015 to 9/30/2023, Data source: Amundi Pioneer
While we believe correlation data is reflective of relationships, these measures are not static and will vary over time, potentially increasing or decreasing the diversification benefit of various investments.
Return Contributions
We also incorporate illiquid investments with the goal of contributing to returns at a higher level than investments available in public markets. Because some types of investments with what we believe to have competitive return potential are not available in highly liquid formats, it is necessary to undertake illiquidity to participate in those areas of the investment universe. Our use of private debt funds, which are illiquid, are an example of this approach. While private debt investments have many similar characteristics to publicly traded debt, we expect there to be a potential for higher returns than public investments over time.
A fund that we own in this category is the Cliffwater Corporate Lending fund, which funds loans primarily to businesses with $25M to $75M in earnings, which are typically too small to issue a multi-billion dollar publicly traded bond, and as a result pay a premium to borrow funds compared to larger businesses.
Another fund we utilize in this category is the Variant Alternative Income fund, which lends money to a wide variety of diversified borrowers and against varying collateral, including senior housing facilities, diamond wholesalers, law firms, and art. While the Variant fund recorded a 1.6% loss in the 2nd quarter due to a loss on an investment in skilled nursing facilities in the UK, we believe returns have been competitive over a multi-year period.
The chart below shows the five-year annualized returns for these illiquid investments (shown in green) relative to publicly traded investments (shown in gray), demonstrating the potential for capturing higher returns through the use of competitive investments with illiquid characteristics.
Returns through 6/30/2024.
To summarize our approach to illiquid investments, we seek to carefully select investments that we expect not to move in lockstep with public investments such as stocks and bonds, and which may have the potential to outperform similar investments within public markets.
Market Returns for the 2nd Quarter of 2024
Returns as of 6/30/2024, for trailing periods. Returns for periods over one year are annualized.
If you would like to review any aspect of your investments or have any questions regarding this message, please contact us and we would be glad to discuss further.
Thank you,
The Wade Financial Advisory, Inc. Team
2024 2nd Quarter Investment Review
Neelesh Champaneri, CFA®, CAIA®
In our quarterly investment update, we’d like to:
Market Summary for the 2nd Quarter of 2024
In the 2nd quarter, the global stock market rally continued, with global stocks as represented by MSCI All Country World Index delivering a ~3% return, led by large growth companies in the US. After a sharp decline in 2022, US tech stocks represented by the Vanguard Information Technology ETF (source: Morningstar) have delivered a cumulative return of ~80% since the start of 2023. Emerging market stocks represented by the MSCI Emerging Market index also performed relatively well for the quarter, with a ~5% gain. The global stock market continues to be driven by optimism for future corporate earnings, and the US stock market remains at elevated prices relative to earnings. Foreign stocks remain close to their historical rate of prices relative to earnings.
The Bloomberg US Aggregate Bond index delivered a total return close to 0% for the quarter, as modest price declines offset interest income, due to a slight move up in rates marginally reducing bond prices. The 10-year US Treasury note, often used as a key measure of the bond market, ended the quarter with a yield of 4.36%, slightly up from 4.20% a quarter ago (source: Federal Reserve Bank of Saint Louis).
Major global economies continue to expand, including the US, Europe, Japan, Mexico, and India, as manufacturing activity improves across most markets. Business spending on capital projects increased as large companies scale their investments in artificial intelligence, and domestic manufacturing, which adds to US economic activity. Job creation and wage increases moderated, reflecting a slower pace of growth for the US labor market relative to recent years.
The Consumer Price Index for All Urban Consumers: All Items in U.S. City Average (CPI) at the end of the quarter reflected a ~3.0% rate of inflation over prices a year ago (Source: Federal Reserve Bank of Saint Louis), which represents a lower rate of inflation than has been experienced in the previous three years. While the rate of inflation on goods has substantially moderated, services and housing costs continue to experience persistently higher inflation rates. A reduction in inflation may provide justification for the Federal Reserve to reduce short-term interest rates, which would generally be expected to stimulate asset prices and economic activity.
The Value of Diversifying Illiquid Investments in a Portfolio
We would like to discuss the potential benefits of incorporating illiquid investments in client portfolios, starting with a brief description of what defines an illiquid investment, and then to explain why we include them in portfolios.
Illiquid investments are assets that cannot be quickly converted into cash without potentially incurring a loss in value. In contrast, stocks and bonds are highly liquid and can be quickly sold on a daily basis close to their market value. Unlike stocks or bonds, which can be easily bought or sold in public markets, illiquid investments require more time to convert to cash. Real estate is an example of an illiquid investment, as the process of finding a buyer, agreeing on a price, and executing a transaction can require a lengthy sales process. While a property could theoretically be sold in a day, the price would need to be below market value to incentivize a quick transaction.
We incorporate illiquid investments in client portfolios to achieve two primary purposes, diversification benefits and contributions to portfolio returns.
Diversification Benefits
To moderate swings in portfolio value, we seek to own investments that do not move in lockstep with other holdings, such as stocks and bonds. When investments move independently of each other, it can help to reduce the degree to which the portfolio declines in value when stocks or bonds experience a downturn.
An illiquid investment that we expect to operate independently of other investments is reinsurance, which is the business of providing insurance to insurance companies. We incorporate this type of investment through ownership of the Pioneer ILS Interval fund. Like other forms of insurance, income is generated by collecting insurance premiums, which are offset by claims paid out. The nature of this business tends to be quite independent of the stock and bond markets, and as a result can provide a diversification benefit.
One way to measure this benefit is through measuring correlation, which reflects the degree to which two assets move in relation to each other. Correlation is measured in a range of +1 (moving entirely in the same direction), to -1 (moving entirely in opposite directions), with 0 representing independent movements. The chart below shows the level of correlation for each labeled asset, with the height of each bar representing the degree of correlation to other assets. We can observe that the correlations for reinsurance are close to zero, while the other assets are moderate to highly correlated, with values of 0.3 to 0.8.
Data from 1/1/2015 to 9/30/2023, Data source: Amundi Pioneer
While we believe correlation data is reflective of relationships, these measures are not static and will vary over time, potentially increasing or decreasing the diversification benefit of various investments.
Return Contributions
We also incorporate illiquid investments with the goal of contributing to returns at a higher level than investments available in public markets. Because some types of investments with what we believe to have competitive return potential are not available in highly liquid formats, it is necessary to undertake illiquidity to participate in those areas of the investment universe. Our use of private debt funds, which are illiquid, are an example of this approach. While private debt investments have many similar characteristics to publicly traded debt, we expect there to be a potential for higher returns than public investments over time.
A fund that we own in this category is the Cliffwater Corporate Lending fund, which funds loans primarily to businesses with $25M to $75M in earnings, which are typically too small to issue a multi-billion dollar publicly traded bond, and as a result pay a premium to borrow funds compared to larger businesses.
Another fund we utilize in this category is the Variant Alternative Income fund, which lends money to a wide variety of diversified borrowers and against varying collateral, including senior housing facilities, diamond wholesalers, law firms, and art. While the Variant fund recorded a 1.6% loss in the 2nd quarter due to a loss on an investment in skilled nursing facilities in the UK, we believe returns have been competitive over a multi-year period.
The chart below shows the five-year annualized returns for these illiquid investments (shown in green) relative to publicly traded investments (shown in gray), demonstrating the potential for capturing higher returns through the use of competitive investments with illiquid characteristics.
Returns through 6/30/2024.
To summarize our approach to illiquid investments, we seek to carefully select investments that we expect not to move in lockstep with public investments such as stocks and bonds, and which may have the potential to outperform similar investments within public markets.
Market Returns for the 2nd Quarter of 2024
Returns as of 6/30/2024, for trailing periods. Returns for periods over one year are annualized.
If you would like to review any aspect of your investments or have any questions regarding this message, please contact us and we would be glad to discuss further.
Thank you,
The Wade Financial Advisory, Inc. Team
This communication contains the opinions of Wade Financial Advisory, Inc. about the securities, investments and/or economic subjects discussed as of the date set forth herein. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENTS BEAR RISK INCLUDING THE POSSIBLE LOSS OF INVESTED PRINCIPAL.
Wade Financial Advisory, Inc. is an investment adviser registered with the Securities and Exchange Commission. Registration of an Investment Advisor does not imply any level of skill or training. A copy of current Form ADV Part 2A is available upon request or at www.advisorinfo.sec.gov. Please contact Wade Financial Advisory, Inc. at (408) 369-7399 with any questions.
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