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Island Light Investment Notes (April 2016)

“Always act in accordance with the dictates of your conscience, my boy, and chance the consequences.”  W.S. Gilbert

Last month, the Department of Labor published new regulations for advisors working with retirement plans and IRAs.  This new fiduciary standard compels the advisor to “act in the best interest of the client”.  We ask, what took so long?  This new standard:

  • Commits the firm and adviser to providing advice in the client’s best interest. Committing to a best interest standard requires the adviser and the company to act with the care, skill, prudence, and diligence that a prudent person would exercise based on the current circumstances. In addition, both the firm and the adviser must avoid misleading statements about fees and conflicts of interest.
  • Warrants that the firm has adopted policies and procedures designed to mitigate conflicts of interest. Specifically, the firm must warrant that it has identified material conflicts of interest and compensation structures that would encourage individual advisers to make recommendations that are not in clients’ best interests and has adopted measures to mitigate any harmful impact on savers from those conflicts of interest.
  • Clearly and prominently discloses any conflicts of interest. Conflicts of interest, such as fees and compensation arrangements not well documented or disclosed, may prevent the adviser from providing advice in the client’s best interest.

We believe that this new rule helps the independent professional advisor and his clients.  Professional financial and investment advice ought to be independent, free of conflicts, suitable for the client’s financial condition and preferences, offered at a fair price.  The importance of professional advice is not only in the selection of securities but also in the construction of diversified portfolios consisting of well-researched securities, and independent guidance provided in times of market turmoil. We welcome the new standard and hope that the professional investment advisor will continue to act as we would like to be treated, were we the clients.

Market summary

Market returns in the month of April, for the most part, were up, bringing markets returns into positive territory for the year, after very poor results from the first six weeks of 2016.  For the first time in 2016, non-US developed markets outperformed US equity markets in dollar terms, helped by a weakening of the dollar, improvements in expectations of economic growth and expansionary monetary policy.  Fixed income returns were positive as credit spreads tightened and commodities were positive as oil prices surged.

A good earnings season, lower PE valuation ratios and the long term positive impact of low oil prices may offset these fears in 2016, leading to low single digit equity returns in 2016, albeit with a lot of volatility and uncertainty. Global equity markets recovered in April with the MSCI All Country World Index (MSCI ACWI) up 1.5% for a 2016 gain of 1.7%. US large cap equity markets were up modestly and are up 2.3% for the year.  Non-US developed and emerging markets gained and US small cap stocks gained enough to be flat for the year.  US Large Value again outperformed US Large Growth.

Energy, Materials and Financials led the US sectors for the month as oil prices jumped to 2016 highs.  Technology was hurt by poor Apple revenues and earnings.

Domestic Fixed Income

Fixed income continues to outperform equities for the year as the combination of lower interest rates and recent tightening of credit spreads helped US  bonds.  The aggregate bond index is up 3.4% for the year through April 30, long dated Treasuries are up nearly 8.0% and TIPS are up 4.8%.  The 10-year US treasury rose 0.6% to 1.83% in April, still off 44 basis points from 2.27%, its 2015 close.  Credit spreads tightened by 18 basis points to 1.56% (BAML US Corp Master). Inflation-protected bonds returned in line with the US aggregate bond index.

Macro View

Market sentiment has turned markedly positive since mid February, as oil’s price recovery, average earnings and stable interest rates calmed market jitters.  The major drivers of global equity returns are the state of the global economy, the actions of the central banks, company fundamentals and valuations.  The US economy is still growing in the low 2%s annually. Global central bank actions remain accommodative, which are net positive for stock appreciation and global liquidity. We see earnings recovering towards the end of the year from a relatively weak first quarter at or above estimates.  This leaves us with valuation, or investor sentiment.  At quarter end, forward PE was at 16.6 times earnings versus the 20 year average of 17.2 times earnings.  Valuations are not stretched at this juncture, and if earnings remain stable or growing slowly, then equity valuation should move in line with earnings.

Summary

Acting in accordance with one’s conscience is a basic tenet of the professional investor’s creed.  While we can’t know the direction of markets, we know that diversified portfolios give us opportunity for gain while limiting exposure to losses.  This is the conscientious way to manage risk and return over the long term and we think the consequences of this approach will be long term beneficial to our clients and ourselves.

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