Investment Committee & IA Department News – 2nd Quarter 2017


Is it any wonder we see the significant rise in “passive” investing, or indexing, when only 19% of large cap managers outperformed their benchmark in 2016? Further, I’m sure it’s not too surprising that we saw record inflows into passive strategies during the first quarter this year in both equity and fixed income. In 2016, passive funds attracted over$504 billion net inflows while active suffered over $340 billion in outflows. Even if one were to set aside the active vs. passive management conversation for the moment – despite the fact that active large cap managers outperforming the index has improved to 46% in the first quarter of 2017 – the decision on asset allocation, beyond individual stock selection, is crucial in driving performance and managing risk over time. Let’s just take the last three years in evaluating eleven different investable asset class categories that retail investors can easily invest in, either on their own or through an advisor. The difference between the best and worst performing index in each of the last three respective full calendar years was 61.09%, 35.69%, and 22.36% in 2016, a year in which just about every category was positive.

Here are a few examples that highlight the challenges, as well as the importance, that the retail investor is faced with in making the appropriate asset allocation decisions. Small Cap outperformed the S&P 500 by almost 10% in 2016, yet significantly lagged the S&P 500 in 2014 and 2015. Emerging Market Equity lagged the S&P significantly in 2014 and 2015, was close behind in 2016, but yet has almost doubled the S&P 500 through the 1st Quarter of 2017. Developed Foreign has lagged the S&P on a calendar year basis since 2013 and significantly on a cumulative basis since this market cycle began in March of 2009, and it is now outperforming year to date. Growth had handily outperformed value as a style of investing in 2015, but then value showed great outperformance in 2016, and now in 2017, growth is over double the performance of value in the first 18 weeks of the year in the large cap space. The list could go on, but we assume you get the gist.

Despite what seems to be significant oscillating asset class performance, the current bull market hasn’t been as kind to an asset allocation portfolio as it has been outperformed by the S&P 500 by 54.7% on a cumulative five-year basis, through February of 2017. However, this has occurred before, and will occur again, depending on certain time periods evaluated. However, it’s important to emphasize that the particular asset allocation portfolio that we’re referencing has only 60% equity, so generally less risk than the S&P 500, which of course is 100% equity. Further worth noting given this current environment is that following these five-year performance phenomenon, asset allocation driven portfolios have handily outperformed in the five years following the period of underperformance. In fact, they’ve outperformed the S&P on a five- year basis to the tune of 4.4% annually, following similar periods of underperformance.

To further extrapolate on this study of five-year time frames by JP Morgan, if we take data over the past 17 years, which spans two full market cycles, going back to the year 2000, the S&P returned an average annualized return of 4.51% through 2016…not too inspiring of a case to just “set it and forget it”. If we compare that to an asset allocation blend with 60% diversified equity, the compounded annualized return jumps to 6.01%. The takeaway: Proper risk mitigation in the portfolio construction process and a disciplined asset allocation proves critical in long-term investment success.


1 Source: Financial Times 1/5/17 referencing data compiled by Bank of America Merrill Lynch
2 Source: Morningstar: Direct Asset Flows Commentary, January 2017
3 In each case, the worst performing index had performance losses of 33.06, 32.86 and 1.05 respectively for each of the last three full calendar years
4Source: JP Morgan Market Summary, March 27, 2017
5 Source: JP Morgan Market Summary, March 27, 2017
6 The average annualized return was calculated by taking the geometric mean of the S&P’s return for each respective year from 2000 to 2016. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
7 The “Asset Allocation” annualized return referenced does not represent an actual index or any Krilogy portfolio model. It represents the geometric mean of returns of a 60% diversified equity portfolio for each respective year from 2000 to 2016 assuming the following weights of certain indexes: 28% S&P 500, 10% Russell Midcap, 7% Russell 2000, 10% MSCI ACWI ex US, 5% FTSE NAREIT All Equity REITs, 5% Barclay CTA, 5% HFRX Equity Hedge, 20% Barclays US Aggregate Bond, 5% Barclays Global Treasury Ex US. No asset rebalancing over the period from 2000-2016 is assumed. Each annual return is a weighted sum of the respective index returns from the respective year according to the aforementioned weighting. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Should you wish to have a description of each index and the calculated asset allocation returns for each respective year, you may request that separately through your Financial Advisor.