Weekly Access

The Global Market Portfolio

3/11/2016

By Michael McKeown, CFA, CPA - Chief Investment Officer

Every few years, authors of the Financial Analysts Journal update a version of the global multi-asset market portfolio.  It considers the total market value of investable assets in the world.  I made some tweaks since the article seems to understate some large asset classes like private equity and real estate.  This provides a framework for analyzing where your portfolio weights compare to a passive version of the world.

Even Nobel Prize winner William Sharpe stated that he “cannot easily understand why funds do not routinely compare their asset allocation with current market proportions.”

We will start with the big picture.  The total value of investable assets is $179 TRILLION, yes with a “T.”  Of that, public equities make up $66 trillion, fixed income securities $93 trillion, real estate $17 trillion, and private equity/venture capital at $3 trillion.  All figures are estimated as of the year-end 2015.

For my purposes, I excluded hedge funds as these are a vehicle to mainly access equity, fixed income, and derivative securities.  At a quite relevant $2.7 trillion, the argument can be made for inclusion, but this would result in double counting a large portion of assets since actual holdings are largely traditional equities and bonds, with leverage.  I also excluded commodities because historically this “asset class” provides a 0% real return with massive volatility (which is worse than cash, over time).  I went back and forth on excluding the $6.6 trillion of negative yielding global bonds as well, but kept them since perhaps one day the yields will be positive and investable again.

Below we have a breakdown of each asset class with regions and sub-asset classes.

The U.S. is still the biggest public equity market, but with Japan and China so large, the Asia Pacific Region is larger than the EMEA region (Europe, Middle East, & Africa).  The surprising items from going through this exercise was how much developed market debt there is outside of the U.S.  It is the largest asset class and sadly the yields are mostly below 2%.  I also was surprised at the size of the U.S. single family rental market, which is an emerging asset class for institutions.  The measly size of private equity was interesting considering all of the media attention.

Here is a look at the values above but presented in proportion to one another as the next level look of the Global Market Portfolio.

Whether an individual or institutional investor, one’s asset allocation will have some difference to the Global Market Portfolio.  The time horizon, liabilities, overall objectives, and risk tolerances all play a factor on whether the right design is overweight equity and underweight fixed income, for example.  Still, it serves as a gauge of where one falls on the spectrum for areas such as Mortgage Backed Securities (MBS) or Investment Grade Corporate bonds.

We think of having more than a benchmark as being “overweight” an asset and less than a benchmark as being “underweight.”  Arguably, the most common overweight positions for external portfolios we review are in U.S. Equity (14% of Global Market Portfolio), U.S. High Yield Corporate bonds (1%), and MLPs (0.2%). 

The most common underweights are to a few areas which I do not mind, since the foreign currency exposure would be too costly to hedge. This includes developed market fixed income and emerging market fixed income (though a modest allocation is surely appropriate).  Most also tend to be underweight real estate (since one’s home rarely is cash flow positive even if it is paid off, I cannot classify this as an “investment).  In addition, most hold an underweight to foreign equities (both developed and emerging, which make up 23% of investable assets).

Where does your portfolio stand relative to the Global Market Portfolio?

 

Sources: Securities Industry and Financial Markets Association, World Federation of Exchanges 2015 Report, Norway Sovereign Wealth Fund Real Estate Study 2015, Prequin, JPMorgan Guide to the Markets, Morgan Stanley Research

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.




3 Watch List Ideas for Investment Committees

2/26/2016

By Michael McKeown, CFA, CPA - Chief Investment Officer

After wrapping up due diligence on fund performance for 2015 across our 401(k) clients, thinking about the message to convey to plan sponsors is on my mind.  Here are a few areas the executives, board members, finance, and human resources teams should think about when reviewing funds.

1. Your bond funds have credit risk – how much is okay at this stage in the cycle?  This expansion is turning seven years old in June (yay!).  The longest economic expansion in history is ten years, so at some point, there will be a recession.  Corporations took out $8 trillion in debt since 2008 and this area will likely be the epicenter in the next economic downturn (unlike the last cycle where household mortgage debt was the powder keg).  Be wary of funds dipping in credit quality compared to previous years.  This could mean the fund is reaching for yield at the expense of capital preservation – not something one wants in the ‘safe’ part of a portfolio.  You will not find this in the returns data of the shiny due diligence report.  Your analyst must dig deeper and not just be a numbers ‘reporter.’

2. After a straight up market the past 7 years, it is tough to catch up with index returns.  Do not sell your quality manager just to do something.  You cannot get those returns back – and if it is a low turnover strategy, you are simply buying high to sell low if you are rotating within the same asset class.  Focus on process over outcomes.  On average, institutional investment consultants do a terrible job of selling managers at the wrong time and buying managers after outperformance.  Simply try to minimize mistakes.

3. Three asset classes (fund categories) that we do not think are appropriate for 401(k) plans include high yield corporate bonds, commodities, and sector specific funds (except REITs).  While it may sound like I am picking on areas that have gone down over the last year, we advised committees against these areas since we started advising plan sponsors on ‘cleaning up’ bad funds lineups.  Asset classes that can permanently impair capital due to very cyclical return patterns or a low historical return premium are inappropriate.

 

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.




2 For the Bulls & 2 For the Bears

2/4/2016

By Michael McKeown, CFA, CPA - Chief Investment Officer

Let’s dive into some important charts.

Leading up to the past two recessions, people dramatically stopped looking for houses.  It began slowing down two years before, as people worry about making a big purchase on credit.  That is not the case today.  Consumers are looking for houses. The National Association of Home Builders shows sales and foot traffic increasing steadily for four straight years. 

There is a ton of noise in investor surveys and not clear signals.  At extremes though, the data gets more interesting.  Only in 2008-09, 2011, and briefly in 2015 have bearish advisors outnumbered bullish advisors.  This is typically a contrarian signal, as when too many people get bearish, there is not anyone left to sell and push prices lower.  Stock prices today are near the same level as the lows of August 2015 when bears outnumbered bulls, but it is important nonetheless for those with bullish outlooks.

It is a bloodbath in the energy sector.  Total asset writedowns for oil and gas companies hit a quarterly record.  The corporate bond market is telling us that energy today is as bad as the telecom bust in 2001 and the financial sector meltdown in 2008.  Will it feed into other sectors that require credit?  That is the bigger question now.

Both large and small banks tightened credit standards for commercial and industrial loans during the last two quarters of 2015.  This was the first consecutive drop during this economic expansion.  Demand for loans also fell in the last Federal Reserve survey of Senior Loan Officers.  This is certainly partly related to the energy fall, but could feed into other areas.  Tighter credit standards and a drop in demand for funds preceded the last two recessions. 

Stay tuned for more charts as we follow the evolving economy and markets.

 

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.




Big Changes to Accredited Investor Definition & Crowdfunding

1/27/2016

By Michael McKeown, CFA, CPA - Chief Investment Officer

When Congress passed the Dodd-Frank Act, there was a provision that said the SEC would examine the accredited investor definition every four years.  Why does this matter?  Per the report (with our emphasis):

“The “accredited investor” definition is a central component of Regulation D.  It is
“intended to encompass those persons whose financial sophistication and ability to sustain the
risk of loss of investment or ability to fend for themselves render the protections of the Securities
Act’s registration process unnecessary.”  Qualifying as an accredited investor is significant
because accredited investors may, under Commission rules, participate in investment
opportunities that are generally not available to non-accredited investors, such as investments in
private companies and offerings by hedge funds, private equity funds and venture capital funds. 

Issuers of unregistered structured finance products and debt securities also may rely on
Regulation D.

The exemptions in Regulation D are the most widely used transactional
exemptions for securities offerings by issuers.  Issuers using these exemptions raised over $1.3
trillion in 2014 alone
, an amount comparable to what was raised in registered offerings."

The definition change also matters because of the ease of investing in private offerings via crowdfunding using online platforms today.  Many sites popped up offering access deals from real estate to technology startup companies and much more.

Since 1982, the accredited investor requirements have been the same - $200,000 of individual income, $300,000 of joint household income, or $1 million net worth (excluding primary residence).

Here is what the SEC recommends from its report issued in December 2015:

  • Grandfather in the previous income and net worth requirements, but subject to 10% investment limitation in any one issuer
  • Increase income threshold to $500,000 and net worth to $2,500,000 (no percentage limitation)
  • Index the threshold requirements for income and net worth to inflation
  • Grandfather issuers' existing investors that are accredited under current definition

In addition, the SEC also recommends the accredited investor definition be expanded to include individuals with the following attributes:

  • Certain professional credentials (Series 7, CPA, CFA, etc.)
  • A minimum amount of investments of $750,000
  • A minimum amount of experience investing in exempt offerings
  • Individuals who pass an accredited investor examination

The SEC estimates there are currently about 12.4 million accredited investor households.  The new inflation-adjusted requirements would impose a limit (10%) on 4.4 million households, which could lessen funds available for issuers under Regulation D.  The limit is probably a pretty good idea to prevent people from "putting all their eggs in one basket."  Including all of the new expanded definitions, the pool of accredited investor households would expand to 14 million.

All of these changes would have a big effect on the private capital markets over time. Record amounts of money flowed into venture capital (VC) the last few years.  Given easy capital access and lower levels of due diligence on crowdfunding platforms, I suspect there will be many failures and few winners of those using the VC platforms (like any portfolio of VC investments).  When VC investments hit though, they will be big, but a huge gamble rather than an ‘investment’ in the end.  Far more interesting to me are the real estate and private equity opportunities with more tangible businesses and quality cash flows.  While not knowing anyone personally, my inclination that those who fail to build a quality peer network of lenders or investors will be the ones using the platforms as sources of capital.  This could result in negative selection bias. At the same time, the pure convenience of the platform and quick execution may make crowdfunding platforms a viable solution for all or a portion of capital raising.

In the future, online crowdfunding platforms could become the norm rather than the exception.  Hopefully there will be an increase in quality and greater due diligence standards on a self-imposed basis by the industry.  Will more qualifying individuals consider crowdfunding as part of basic asset allocation?  Could this be offered in 401(k) plans in the future? 

It will be really interesting to see what, if any, of the SEC recommendations become law and the subsequent impact on crowdfunding and individual investors. Keep an eye on this, we sure will.

 

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.




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