Island Light Investment Views, Q2 2016

Investment Views

Our investment team makes a series of investment decisions based upon our current outlook on the US and global economy, global equity and fixed income markets.  Every quarter, we produce new capital market estimates that we use to manage our portfolio allocations within and between major asset categories and subclasses in order to benefit from changing conditions in global capital markets.

Q1 2016 Review: Performance, Market and Economy

Global equity markets zigged and zagged during the first quarter, with all major equity classes falling into correction territory before recovering in late February and March.  Given the fears at the beginning of the year, it is surprising that the US equity market ended the first quarter up 1.4% (S&P 500).  While non-US markets remained below their beginning of year values, non-US equity performance was -0.4% (MSCI ACWI xUS) for the year through March 31.  The US dollar fell back from last year’s highs due to dovish Fed policy, a weaker but still growing US economy, and higher oil prices. US Bonds gained for the quarter as interest rates fell and credit spreads tightened, earning 3.0% for the quarter.

The best performing major asset classes were the losers in 2015, as non-US emerging markets gained 5.7% and gold returned 16.5%.  US value-oriented stocks and larger capitalization stocks also fared better in the first quarter, with large value returning 2.2%. Interest rates declined during the quarter and inflation remained muted, benefitting interest-sensitive assets such as fixed income, REITs and MLPs as investors remained concerned about slow US economic growth.

Capital Market Estimates and Views

Capital Market forecasts and estimates are critical components in the development of our portfolio allocations.  When creating capital market forecasts, we employ sophisticated statistical techniques to combine observations of history with current information and forward looking views. This advanced and unique forecasting process is rigorous, transparent and practical, allowing us to include technical, quantitative factors and investment intuition to manage our investment portfolios in a consistent dynamic framework. We share our current and forward looking views, and the strength of those views here.

Portfolio Construction Methodology

We use advanced portfolio optimization technology to turn our capital market assumptions into investable portfolios.  This patented asset allocation methodology is designed to improve risk-adjusted returns through enhanced diversification of asset classes, selected to satisfy a range of investment objectives.

Investment Outlook – Q2 2016 as of April 1, 2016

Investment Outlook – Q1 2016

We expect the US economy to continue to grow at around 2.5% with moderate confidence and US inflation over the short/mid term to remain moderate, with moderate confidence.  We also expect earnings for the largest companies in the US to grow between 4% and 7% this year.

Overlay View – Equities

Asset Class Valuation (Global Equity Risk Premium): we expect the Equity Risk Premium to be average (6.0%) with higher confidence
Developed Equity Timing (US vs. non-US developed market equities): we are neutral US versus non-US developed equities with moderate confidence
Emerging Equity Timing (Non-US Emerging equities vs US equities): we have increased our view on Emerging Markets from negative to neutral with moderate confidence
US Equity Style Tilt (US value vs. US growth equities): we have changed our view so that we are now neutral on US growth versus value equities with moderate confidence
US Equity Size Tilt (US large-cap vs. US small cap equities): we favor US large-cap equities with low levels of confidence

Overlay View – Fixed Income

US Interest Rate direction (US interest rate expectation – short/mid): we expect interest rates to increase modestly with moderate confidence
US Bond view (US short bond forecast vs. inflation): we expect that bonds returns will equal the inflation rate with lower confidence
US Yield Curve Timing (US long bond v. US short bond): we favor shorter duration bonds with lower confidence
US Inflation-Protected Bond (US bonds vs. US inflation-protected bonds): we favor US bonds over TIPS with lower confidence
US Credit Spread (Credit Spread vs Treasuries): we see the credit spread decreasing with moderate confidence
Non-US Bond View (Hedged non-US Bond vs US Bond): we favor non-US Hedged Bond with moderate confidence

Overlay View – Other Assets
Global REITs Timing (Global equities vs. Global equity REITs): we favor US equities with lower confidence
Commodities Timing (US commodities forecast): We are negative on commodities with moderate confidence
MLPs Timing (Equity MLPs vs US equities): we are negative on MLPs with low confidence
Global Macro Timing (Global Macro expectation): We are neutral with moderate confidence

“Confidence” is the strength of our forecast rating from Low to High.

Island Light is pleased to share our capital market forecasts with professional investors who ask for them. Please drop a line or give us a call for our capital market forecasts for the upcoming quarter and year. Our capital market assumptions are forecasts and reflect our forward looking views as of April 1, 2016. Such views do not express or imply a guarantee or warranty of any kind, but are estimates of future market returns. All views expressed above are the views of Island Light Capital.

Past performance does not guarantee future results, which may vary.

Note: All views were generated by our investment team using quantitative models, current information and our best estimate of future conditions.  All views are subject to change.  Opinions expressed are current opinions as of the date appearing in this material only.  Views expressed herein may not always be reflective of the actual portfolio allocations due to other information including correlations between asset classes, investment and policy constraints, and other investment restrictions.

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