Financial Landscape – December 2019

Global Macro Environment

Global Fundamentals Modestly Improving
The US consumer continues to be the workhorse for the economy. Real GDP in the third quarter was revised higher to 2.1% from 1.9% and the Atlanta Fed’s tracking estimate for the fourth quarter is currently at 1.3%, up from 0.3% as of November 16. Friday’s strong job report showed robust hiring in November as employers added 266,000 jobs and the unemployment rate matched a fifty year low. Another key support is US housing, as new home sales remained in an uptrend with October reporting 733,000. The risk continues to be trade and the November release of the Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) is signaling that the US is feeling some pressure. The US ISM PMI declined back to the cycle low at 47.2 from 48.3 in October.

In Europe, subtle improvements in German manufacturing data has been temperately hopeful. Germany’s heavy export economy is seen by investors as a good barometer of global activity. For most of the year Germany has been dealing with a slowdown in China, possible auto tariffs from the US and Brexit, so the recent improvements have been welcomed by investors. Improvements were also seen in China’s economy as the Caixin services PMI rose to 53.5 in November, a seventh month high, while the manufacturing PMI rose to 50.2 ending six straight months of contraction.

Fed Moving On To 2020
The Federal Reserve has lowered the fed funds target rate three times in 2019, but indicated a likely pause in December. The possibility of an insurance cut in the first quarter of 2020 has been mentioned in the media, however, it would take a very weak December jobs report and deteriorating US consumer data to be seriously considered.

Trade Intensification
The last few weeks the rhetoric between the US and China indicated that the two sides were close to a deal, or at least a “phase one deal.” The steel and aluminum tariffs announced on December 2 suggest that this might not be the case. Rationale for the tariffs, delivered by the President via twitter, was over currency devaluation but looking past the 240 character tweets would suggest something else. Brazil and Argentina, the countries targeted by President Trump via the tariffs, are set to sign agricultural deals with China. This would make China less dependent on US farmers, whom the President has vowed to protect.

On the same day as the steel and aluminum tariffs were announced, the Trump administration also proposed tariffs of up to 100% against $2.4 billion of French imports. The administration said the tariffs are justified because of a new digital-services tax imposed by France that weighs heavily on US technology companies.

These new trade developments will certainly not help business confidence.

Market Observations

US Equities
The S&P 500 gained 3.6% in November bringing the year-to-date performance to 27.6%. Large cap growth led value on a monthly basis but value has outperformed growth over the prior quarter (8.3% vs. 7.4%). Overall small cap performance (+4.1%) was strong in November as well bringing the year-to-date performance to 22.0%. Similar to large cap, small cap growth led value last month, but the value outperformance over growth is even wider on a three month basis (10.2% vs. 8.0%). Information technology (+5.4%) and financials/healthcare (+5.0%) led all the sectors in November, while utilities (-1.8%) was the sole sector with negative performance.

International Equities
Developed international markets had a positive month, unlike emerging markets, as the MSCI EAFE gained 1.2% and MSCI EM fell -0.1%. Within regional developed markets, Europe outperformed Australasia/Far East (1.5% vs. 0.5%). Protests, social unrest and political turmoil continue to hurt Latin American emerging markets. The region was down -4.1% in November.

Fixed Income
The Bloomberg Barclays US Aggregate Index was slightly down for November at -0.1%. The US ten year yields are up about 10bps since the end of the third quarter. Investment grade corporate credit (+0.2%) and high yield (+0.3%) continue to perform well. In the municipal space, favorable supply-demand dynamics, solid state and local balance sheets and net rating upgrades vs. downgrades all look to be possible tailwinds.

Real Assets
Natural resources (+1.6%) had a positive month while MLPs (-5.8%) and real estate (-1.2%) fell. US crude oil has traded between $50 and $60 a barrel for a majority of the last six months. Energy analysts say this range benefits both producers and consumers. Globally, the Organization of the Petroleum Exporting Countries (OPEC) met last week in Vienna. Saudi Arabia is pushing OPEC to continue with the previously agreed upon output cuts but said they will boost production if other members do not adhere to the agreement.

This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 12.5.19 and is subject to change at any time due to market or economic conditions or other factors. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

The Financial Landscape – November 2019

Global Macro Environment

Global Growth Near the Bottom
The October US jobs report showed a gain of 128,000 month over month. A good result after factoring in the GM strike, which has now been resolved. The unemployment rate ticked up to 3.6% from 3.5% in September, the lowest rate the economy had seen since December 1969. US GDP rose at an annual rate of 1.9% in the third quarter, a slight decline from the 2.0% reading in the second quarter. The US consumer continues to carry the torch keeping economic growth on track, while an improvement in the housing sector also provided a boost. The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) rose slightly to 48.3 in October but is still in contraction territory for the third straight month.

In Europe, third quarter GDP rose 0.2%, confirming the European economy is maintaining stall speed, while Brexit volatility presents an ongoing headwind to consumer confidence in the UK. China’s economy is still searching for the bottom with manufacturing PMI falling to 49.3, the sixth month of contraction.

Fed Signals Pause After Third Cut
The Federal Reserve lowered the fed funds target rate for the third time this year and began to downplay expectations of further easing. The released statement signaled a higher bar for additional cuts and removed the wording “will act as appropriate to sustain the expansion.” As a result of the statement, along with the October jobs data, the market-based probability of a fourth cut this year is currently below 25%. The European Central Bank (ECB) will restart their asset purchase program in November.

Geopolitical Risks
Below is a timeline of important Brexit updates from October:

  • October 17: UK/EU draft revised Withdrawal Agreement.
  • October 22: Parliament votes 329 to 299 in favor of agreement.
  • October 28: UK/EU extend Brexit deadline to January 31, 2020, avoiding a possible “no-deal” Brexit on October 31. The EU also agreed an earlier divorce is possible if the UK Parliament passes a deal.
  • October 29: Parliament votes 438 to 20 to hold a general election on December 12.

The outlook on Brexit is still cloudy and any prediction on what will occur December 12 seems futile. However, the probability of a “no-deal” Brexit looks to have collapsed, which should be applauded by the global economy.

Optimism seems to be growing that the “phase one deal” with China announced by President Trump earlier in October will likely materialize. A minor speed bump occurred when Chile canceled the APEC Summit, where both parties were expected to finalize the agreement, due to local unrest. As of this writing a new location or event has not been scheduled.

Market Observations

US Equities
The S&P 500 has gained 23.2% year-to-date through the end of October. According to Strategas, that result puts the index in the top decile of historical performance through the first ten months of the year going back to 1950. October performance was strong at 2.2%. Healthcare (5.1%) and information technology (3.89%) led all the sectors during the month. Large-cap growth stocks returned 2.8% compared to 1.4% for large-cap value. Growth led value within small-cap as well with small-cap growth and value returning 2.9% and 2.4%, respectively. Energy was the worst performing sector in October with a return of -2.3%.

International Equities
Developed international markets had a good month as the MSCI EAFE gained 3.6%. Growth has led value year-to-date through the end of October as the EAFE Growth Index returned 23.0% vs. 12.1% for the EAFE Value Index. Through month-end, within emerging markets, Russia (40.4%) and Greece (36.9%) have led the way in Eastern Europe, while Colombia (22.7%) and Brazil (17.6%) have outperformed in Latin America.

Fixed Income
Rates trended higher during October as investor sentiment was positive within risk assets. The Bloomberg Barclays Aggregate Index returned 0.3% for the month, while the Treasury curve steepened. Ten-year yields are up about 30bps since the early September low. Investment grade corporate bonds outperformed th e duration-equivalent Treasury index by 60bps in October. In the municipal space, favorable supply-demand dynamics, solid state and local balance sheets and net rating upgrades vs. downgrades all look to be possible tailwinds.

Real Assets
Natural resources (3.0%), MLPs (0.7%) and Real Estate (2.4%) all gained ground in October. Tensions still remain elevated with Iran in the aftermath of the Saudi Arabia drone strike. As trade talks develop, President Trump is hoping China will purchase somewhere between $40B – $50B worth of US agricultural products in the “phase one” agreement.

This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 11.12.19 and is subject to change at any time due to market or economic conditions or other factors. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

Private Equity Co-Investing: Getting More Than What You Paid For

Private equity investing has long been seen by sophisticated investors as a means of generating returns in excess of what is available in the public markets realm. It is well documented that institutions such as Yale’s mammoth endowment fund have used private investments for decades to enhance portfolio performance. Likewise, many of the wealthiest families in the world have made private equity a prominent component of their portfolio mix.

 

It is not hard to understand these investors’ fascination with private equity. While actual results vary significantly across individual “vintage years,” annual excess returns of 3-5% or more over the life of a private equity fund has not been unusual.*

But What About Those Private Equity Fees?

While private equity investing has often produced attractive results, the fees charged by general partners (“GPs”) can be commensurately high. GPs command high fees for their specialized expertise and the intensive hands-on management that private equity investments require. Most private equity funds adhere to the classic “2 and 20” fee model, that is, a 2% annual management fee plus a 20%-of-profits incentive (a.k.a., the carried interest). As a result of these fees, a fund that generates a 20% gross annual Internal Rate of Return (IRR) over its life will pay roughly 5-6% annualized to its GP. While the resulting net IRR to the investor may still be quite attractive (14-15% in this case), the fee bite is nonetheless enough to give some investors pause. (Note: all returns in the prior table are net of fees).**

Introducing Private Equity Co-Investing

Private equity co-investing is one way large, sophisticated investors have reduced their private equity fee burden. Private equity co-investments can be broadly defined as minority (i.e., non-control) investments in direct private equity deals made available through a fund GP. Co-investors invest alongside (but outside of) the GP’s fund. GPs seek out co-investors when they have identified a relatively large deal that would create an over concentration in their fund. GPs “right size” the position by splitting it between co-investors and their fund. For example, in the below illustration the GP’s private equity fund purchases a 70% controlling position in the target company, while the remaining 30% is purchased by two minority co-investors.

Co-investors allow the sponsoring GP to close a deal with the target company by providing additional capital on a timely basis. Without co-investors, the GP would likely be forced to either share the deal with a competing private equity firm or walk away entirely. Because co-investors are providing an important service to the GP, GPs will often agree to waive their “2 and 20” compensation model on co-investment capital, saving co-investors significant basis points in fees.

An Exclusive Club

Not surprisingly, the prospect of investing in private equity deals on a “no-fee” basis has created tremendous investor appetite for co-investment opportunities – especially those co-investments sponsored by top GPs. For these top GPs, participation in their co-investment opportunities is by invitation only. Those investors receiving such coveted invitations typically share three common characteristics:

  1. They are significant investors in the GP’s private equity fund (i.e., they are already a valued client).
  2. They possess the expertise to evaluate direct deals and make informed investment decisions.
  3. They have access to a significant pool of capital that can be deployed without delays.

As a result of Oxford’s decades-long experience sourcing private equity funds (i.e., our “Regent Street” platform) and direct deals (i.e., our “Mayfair” platform), we believe Oxford is uniquely situated to access attractive co-investment opportunities.

Conclusion

Arguably, investors in private equity funds have earned substantial excess returns relative to public equity markets. This return advantage comes despite a fee load that is typically higher than traditional investment classes. Private equity co-investments are hard-to-access direct private equity investments offered by fund GPs in need of additional capital to close a new deal. Sophisticated investors see co-investing as a means to dramatically lower fees, without sacrificing investment quality. Oxford’s scale, network and experience has uniquely positioned us to access and evaluate co-investment opportunities for the benefit of our qualified clients.

*Past performance is no guarantee of future results. The time periods illustrated may not represent current conditions.
**The amounts and returns represented are for illustrative purposes only and are not intended to represent actual returns that an investor should expect.
The above commentary represents the opinions of the author as of 10.25.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

 

Financial Landscape – October 2019

Global Macro Environment

US Joining Global Growth Slow Down
The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) fell further below 50 in the US indicating a contraction of manufacturing. However, the US economy is still hanging tough, due partly to manufacturing representing a smaller share of GDP than in most other economies, such as China and Germany. A key metric to monitor is non-manufacturing (i.e., services), which has largely been impervious to the trade tensions. The European consumer provided some positive data for the bloc as unemployment ticked down to 7.4%, a new cycle low, and retail sales increased approaching cycle highs. Similar to the US, consumption is key to economic activity, and the main driver of consumption is employment. However, possible tariffs from the US on EU goods should be monitored. Japan’s consumer confidence fell in September, a concerning result ahead of the VAT hike on October 1. These headwinds signal the likelihood of a difficult fourth quarter for the Japanese economy. In China, tensions with the US and Hong Kong remain as the Communist Party celebrates its 70-year anniversary. The manufacturing PMI for China continues to hover around the critical 50 mark.

Fed Cuts: Not If, But How Many?
After the September fed funds rate cut of 25bps, officials were split over the outlook moving forward. Opposing data in early October (weak manufacturing data versus strong employment data) will test the group’s data-driven thinking. As of this writing, bond investors are pricing in a 75% probability of a rate cut in late October.

Geopolitical Risks
The U.K.’s top court ruled that Prime Minister Boris Johnson acted unlawfully when he suspended Parliament for five weeks, opening the door to new challenges to his Brexit strategy. The Supreme Court said the prime minister misused his authority to advise Queen Elizabeth II to suspend Parliament from September 9 through October 14. Johnson most likely will not be able to call an election before the October 31 deadline to leave the EU, and therefore another delay is the most probable outcome.

US and China tensions appear to have decreased over the last month, though the situation remains fluid. President Donald Trump again postponed some tariff increases, and China has agreed to buy agriculture goods, specifically soybeans and pork. China’s stall strategy to wait out President Trump in hopes for someone more amicable, like Joe Biden, took a hit as Elizabeth Warren’s recent surge in the polls has her as the frontrunner for the Democratic nomination. For all of the differences between President Trump and most of the Democratic nominee candidates, a protectionist stance on trade with China is one that both the President and Warren share. For China, trying to work out a trade deal with the “devil you know” as opposed to the “devil you do not know” may seem like a better path.

Market Observations

US Equities
Equities rebounded in September led by value stocks, which returned 3.6% relative to growth at 0.0% for large cap companies and 5.1% relative to -0.8% for small cap companies. At the end of the third quarter the broad market posted its best performance in the first three quarters of the year since 1997. However, analysts are forecasting a negative earnings period for the S&P 500 in the third quarter. Year-over-year earnings growth in the first two quarters came in slightly positive. Companies reporting early results in the technology and financial sectors, the two biggest sectors in terms of earnings contribution, should give investors a preview into whether those forecasts will be accurate.

International Equities
International economies tend to be more trade dependent and thus are more sensitive to global economic momentum. As a result, slowing global growth will continue to remain the biggest risk for equities in this region. Through September 30, 2019, developed international markets returned 12.8%, behind both US large and small cap equities (20.6% and 14.2%), and emerging markets lagged even further at 5.9%.

Fixed Income
The brief spike in the Secured Overnight Financing Rate (SOFR) above 5% last month grabbed investors’ attention. The Fed scheduled offerings of at least $75B in market repurchase agreements, or repos, beginning September 23 through October 10. As the Fed increases the size of its balance sheet, this will lead to higher excess reserves, thus easing global liquidity conditions. Falling yields this year have provided a nice return for bonds, the Bloomberg Barclays Agg is up 8.5% through the third quarter.

Real Assets
The Saudi Arabia drone strike last month was the largest oil supply disruption in history, wiping out 5% of global oil production instantly. Prices surged following the attack to almost $70 per barrel but have since fallen back under $60 per barrel. Tensions will remain elevated with Iran, after the US, Britain, France and Germany all concluded that Iran was behind the attack, likely keeping oil price volatility high.

This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 10.11.19 and is subject to change at any time due to market or economic conditions or other factors. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

The Financial Landscape – September 2019

Global Macro Environment

Global Growth Slowing
Economic data in Europe continues to be unpromising. Brexit uncertainty continues to rattle the UK economy. The results led the European Central Bank to cut the key interest rate at their September meeting. The ECB also launched a fresh new package of bond purchases, a move aimed at insulating the Eurozone’s faltering economy from the global growth slowdown and trade worries. Data coming from Asia, specifically Japan and China, has been lukewarm. Tensions in Hong Kong and Japan’s upcoming VAT hike in October have been headwinds for both countries.  The labor market, household finances and the US consumer are keeping recession odds at bay. The latest reported retail sales and private expenditures numbers reached all-time highs. However, consumer sentiment may begin to show signs of weakness as tariff fears continue. Consumer sentiment (e.g., University of Michigan) weakened in August, and the Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) fell below 50 indicating a contraction of the index. Non-manufacturing is still providing good support and the US consumer story continues to be responsible for the vast majority of GDP growth.

Fed Cuts: Not If, But How Many?
The Fed cut interest rates another 25bps at the September meeting. A 50bps cut was floated around as a possibility by analysts and economists but the US jobs report put that to rest. At the previous rate cut meeting, Chairman Powell referred to it as a “mid-cycle policy adjustment.” Markets will be watching for any other signals it can glean from the Chairman, as the trade war and global economic outlook have not improved since the previous meeting.

Geopolitical Risks
The US and China are looking to get back to the table after China imposed tariffs on $75 billion worth of additional US products and President Trump indicated he regrets not escalating tariffs further. Chinese experts at the Hudson Institute think this tactic is exactly how President Xi and his advisors want to play it. They believe they can extract better terms by not hurrying into concessions, but also want to appear willing to negotiate. The reality is that nothing material has changed between the two countries recently and so any future talks make a large deal highly unlikely. The Hong Kong situation is another risk to monitor as protests have gone back-and-forth between peaceful and violent. Millions of demonstrators have taken to the streets to protest a now shelved extradition bill and full democracy.

British lawmakers voted to again delay Brexit, thwarting Prime Minister Boris Johnson’s signature pledge to take Britain out of the EU at the end of October and setting the stage for a general election this fall.

Market Observations

US Equities
A flight to safety by investors worried about global growth, America’s trade war with China and now a currency battle led equities lower in August. Defensive areas of the market held up relatively well, which should not be a surprise given the fact that the entire US yield curve trades below the Fed Funds Rate. Earnings and revenue growth came in better than expected for the second quarter (+3.2% Y/Y earnings and + 4.7% Y/Y top line revenue.)

International Equities
International equities stand to benefit from the recently announced stimulus package by the ECB. European industrial stocks have performed well this year and could see a tailwind from this policy decision. Given the tight trade relationship between China and emerging markets economies, additional stimulus implemented by China to prop up their domestic economy could be beneficial.

Fixed Income
Global bond yields this year have closely tracked the course of global growth. Global liquidity and low sovereign yields of major European countries have been key to the fall in US Treasury yields. Recently, dollar quality and a flight to safety have further accelerated the fall in yields. The 30-year Treasury yield broke below 2% for the first time in history on August 15. The total market cap in negative yields continue to rise around the world.

Real Assets
Crude prices surged Monday, September 16 in the aftermath of the weekend attack on Saudi Arabia’s crude production infrastructure. American officials say intelligence indicates that Iran was the staging ground for a debilitating attack and the officials have shared the information with Saudi Arabia. US crude futures ended the day 15% higher at $62.90/bbl, the largest one-day climb since January 2009. Middle East tensions between the US and Iran should continue to keep oil volatility high. In precious metals, gold prices continue to benefit from safe haven demand.

This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 9.20.19 and is subject to change at any time due to market or economic conditions or other factors. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

There Are No One-Handed Economists

In the years immediately after WWII, as he sought to implement the Marshall Plan, Harry Truman was quoted as saying: “Give me a one-handed economist. All my economists say ‘on one hand…’, then ‘but on the other…”

As fundamental data-driven investors we never run out of hands. This is part of the opportunity and challenge as we seek to build enduring portfolios to help our clients achieve their long-term goals.

Today we note the fairly significant disconnect which has existed between the tentative mindset of business leaders and the fairly upbeat US consumer over the past 12 months. On the corporate side, one telling sign comes from the Global Business Outlook, a quarterly survey of CFOs. At this point, 53% of respondents believe there will be a recession over the next four quarters. This figure is an increase from 38% six months ago. This sentiment was reflected in the second quarter’s decline in business investment and the Purchasing Managers’ Index, which fell below 50 in August, indicating a contraction.

In addition, the small business confidence index, which saw a significant spike immediately after the Presidential election, has seen meaningful deterioration since last fall. This is due to a combination of global trade friction, weakening economic conditions in Europe and Brexit. While people can (and do) credibly argue that certain trade practices, such as excessive government subsidies and forced technology transfers, are unfair and need to be remedied, the process of identifying and trying to renegotiate these imbalances brings a meaningful degree of uncertainty.

The recently implemented tariffs and threats of others have impacted trans-Pacific trade volumes as well. The Port of Long Beach, which is the second largest port in the US has seen a 5% decline in loaded inbound container cars thus far in 2019.

Though much could be written about Brexit, which entered a new chapter in July under the leadership of Boris Johnson, and is lurching towards its October 31 deadline, a more tangible sign of risk lies across the pond. The German economy, which is the export engine of Europe, saw a 0.1% decline in quarter-over-quarter GDP. This was driven by a contraction in the country’s manufacturing sector.

On one hand:

If we assume the average consumer does not closely follow the issues of global trade, it makes sense that he/she carries on without worry. The labor market continues to be strong, with the unemployment rate holding at or below 4% since early 2018. Beyond the recent wage gains, we have seen companies rolling out low-cost benefits like flexible office hours, relaxed dress codes and expanding telecommuting policies to retain valued employees. A benign inflation environment and low interest rates potentially being made lower by the Federal Reserve’s rate cut in September have benefited the consumer, whose spending was up 4.7% in the second quarter. As a frame of reference, US consumer spending accounts for almost 70% of US GDP, and 16% of Global GDP, so the mindset of the American shopper cannot be overstated.

On the other hand:

There are some signs that the persistent concerns weighing on businesses might be making their way to the consumer. The August sentiment survey reflected a marked decline, although this looks similar to the drop off in January 2019, so we caution that one data point does not make a trend.

Another closely watched indicator of consumer health is recreational vehicle (RV) sales, which are large and highly discretionary purchases. After two record-setting years there has been a notable decline in 2019 dealer orders. Though delivery logistics and tariff fears impacted some inventory management decisions, any sustained increase in gas prices due to the drone attack on a Saudi oil processing facility would be a broader economic headwind.

From an investment standpoint, we are closely watching the fortunes of corporations and consumers. While lower interest rates have benefited both groups, corporate borrowers have seen a more significant loosening of lending standards. As such, Oxford’s views have become more favorable on consumer credit in our portfolios.

While President Truman never received his wish, in time, we will know whether these hands can work together and meet with a celebratory high five, or an arm-wrestling match. In the event of the latter, we are rooting for the consumer.

The above commentary represents the opinions of the author as of 9.25.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

Trust but Verify

When considering the appointment of a Trustee in connection with your estate plan it is vital that careful consideration be given to the selection of your Trustee. The duties and responsibilities of an individual Trustee can be technical, burdensome and time-consuming.

A Trustee is a Fiduciary role with a duty to follow the terms of the trust, which may include the following items:

  • Control and preserve property
  • Make property productive
  • Provide an accounting to the interested parties
  • Select investments under a Prudent Investor standard (unless the trust document provides more specific terms)
  • Protect the confidentiality of the trust from outside third parties
  • Enforce claims on behalf of the trust
  • File state and federal fiduciary tax returns
  • Fulfill a duty of loyalty to avoid conflicts of interest and self-dealing

While the above list of duties and responsibilities is long, it is not comprehensive. A Trustee may also need to manage real estate, run a family business, or even care for the needs of a disabled person. A Trustee may also be managing a charitable foundation. Finding the right Trustee for the purpose of each specific trust is key to having successful results.

Some people prefer to appoint a Trustee within the family’s inner circle. It is important to remember that a Trustee must be impartial and retain the objectivity to make decisions based on facts and law rather than personal feelings. Appointing one child Trustee over another may result in unintended consequences and family conflict.

It is equally important to plan for the role of a Successor Trustee to replace an existing Trustee in the event of death or incapacity. Many people select a Corporate Trustee for this role to ensure a smooth transition. A Corporate Trustee will be experienced with the technical aspects of trust administration but may benefit from having a family member serve as a Trust Protector or Trust Distribution Advisor to provide important family information pertinent to the administration of the trust.

The liability of a Trustee must also be considered should a conflict arise. If it is determined there was a breach of duty as trustee, one could be held personally responsible. Deadlines for administering a trust must be met, tax returns must be filed, trust terms must be followed or a beneficiary may make a valid claim.

Many trusts are designed to provide flexibility to accommodate the changing needs, goals or objectives of the Grantor of the trust. If you are re-considering the selection of your Trustee, please contact your Oxford team of advisors to review the many options available to your family.

The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

The Value Premium: Is It Different This Time?

All successful investment strategies experience periods of underperformance. It’s prudent at such times to examine whether something has fundamentally altered the source of a strategy’s outperformance. Often, challenging times provide tremendous opportunities for investors with the discipline and conviction to stay the course. The value premium, a reliable source of excess returns for many decades, has recently experienced a prolonged period of underperformance. Has this created an opportunity or is it different this time?

Explanation of the Value Premium

The value premium reflects the excess return investors have historically earned owning inexpensive stocks vs. expensive stocks. The value premium was first identified by Eugene Fama and Kenneth French. Fama and French highlighted the outperformance over time of stocks with High Book to Market (value) relative to those Low Book to Market (growth). From 1927 to June 2019, the value premium using this metric has been 3.1% per year and value stocks have outperformed growth 87% of the time over rolling 10-year periods. Further research has shown the value premium to be persistent over time, across geographies and economic regimes.

The persistence of the value premium has been explained with both risk-based and behavioral explanations. Value stocks tend to be lower quality businesses, often with more cyclical earnings, higher leverage and lower returns on capital. Thus, investors require a premium to own these businesses which may be more susceptible to drawdowns in difficult economic times.

Behavioral explanations focus on investors’ tendency to be overly optimistic about the prospects for high growth stocks and overpay for them. In contrast, businesses experiencing distress are often neglected by investors. A company’s stock performance is ultimately dependent on how the business performs relative to the expectations priced in by investors. When the expectations are ratcheted down for high growth stocks, the price impact can be severe. The low expectations for value stocks results in fewer disappointments.

The Demise of the Value Premium?

Prior to the current period, the value premium was last negative at the peak of the technology bubble in 1999-2000. The expansion of the internet offered the potential to transform industries and drive long-term growth. Investors ultimately priced in wildly optimistic expectations for technology stocks which failed to be met. The value premium in the decade following the peak of the technology bubble was over 4% per year.

Many of the arguments today for the demise of the value premium are comparable to those made during the technology bubble. Some suggest that a small number of disruptive companies are gaining a disproportionate share of economic profits at the expense of legacy companies. Amazon’s tremendous success and the struggles of the retail sector are a primary example. Facebook, Amazon, Google and Apple have developed dominant franchises which have benefited from internet penetration. Time will tell if their competitive positions are more sustainable than some of the largest companies at the top of the technology bubble. Of the top 10 holdings in the S&P 500 in 1999, only three currently trade with a higher market value today, twenty years later.

Growth stocks do typically grow earnings faster than value stocks, though often not fast enough to meet expectations. Growth outperformance does not appear to be justified by a widening in the earnings growth rates between growth and value stocks. In fact, earnings growth for the Russell 1000 Value has exceeded the Russell 1000 Growth over the past 10 years, though coming off a cyclical trough.

An important long-term driver of the value premium has been the significant underperformance of unprofitable growth stocks, particularly in the small cap market. Dimensional Fund Advisors (DFA) tracks an index of small cap growth businesses with low profitability. From 1975 to June of 2019, the DFA US Small Growth/Low Profit index has underperformed the broader small cap market by 9% per year. Since the start of 2017, these unprofitable small cap growth businesses have returned 23% per year vs. 5% per annum for the small cap index. The only prior time this speculative group outperformed to this degree was during the technology bubble. History would suggest this is not sustainable.

The broader universe of growth stocks has seen a meaningful increase in valuation over the last several years. While value stocks have also benefited from rising valuations, their discount relative to growth is at levels only approached during the technology bubble. Once again, investors are pricing in material fundamental outperformance for growth stocks relative to value. If these optimistic expectations are not realized, value stocks will again outperform.

Sir John Templeton famously stated, “The four most dangerous words in investing are: ‘it’s different this time.’”  We believe this is appropriate advice when considering the value premium. The persistence of the value premium over time, and across markets, and the strong fundamental basis for its existence lead us to conclude that recent underperformance provides an opportunity.

The above commentary represents the opinions of the author as of 8.26.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

The Financial Landscape – August 2019

Global Macro Environment

Global Growth Slowing
Global economies appear to be approaching stall speed. The Purchasing Managers Index contracted in the Eurozone for the sixth consecutive month, China’s economy seems to be fading from the tariff impact and the UK is experiencing fragile domestic demand due to the uncertainty around Brexit. Given this backdrop, the European Central Bank signaled it is prepared to cut short-term rates for the first time since early 2016. Economic growth in the US remains resilient by comparison. The second quarter grew at a healthy clip (2.1% annual rate) as higher consumer spending offset a decline in business investment. Non-manufacturing is still providing good support versus manufacturing and the US consumer story continues to be responsible for the vast majority of GDP growth.

Fed Cuts: Not If, But How Many?
The Fed delivered the first interest rate cut since 2008 at their July meeting in a proactive strike to cushion the economy from a global slowdown and escalating trade tensions. Officials also announced they would end the runoff of their $3.8 trillion asset portfolio two months earlier than previously expected. Chairman Powell signaled this was a mid-cycle policy adjustment, but the bond market is currently pricing in multiple cuts for the rest of 2019.

Geopolitical Risks
The end of July and beginning of August brought renewed escalation to the trade war. Tedious progress in negotiations seemed to be a new tactic from Beijing, which increasingly thinks waiting may produce a more favorable agreement. Chinese experts have said that Beijing wants to appear willing to negotiate, but thinks they can extract better terms by not hurrying into concessions. President Trump, sensing this, said the US would impose 10% on an additional $300B in Chinese goods and products beginning September 1, after trade talks failed to yield any significant results. The resulting tariffs have officially cost China its position as the top trading partner of the US, as exports and imports between the two largest economies continue to fall sharply. China’s retaliation came in the form of currency depreciation, as it allowed the Yuan to fall and breach the psychological ceiling of 7.0 USD/CNY, leading the US to label China a currency manipulator for the first time since 1994.

Boris Johnson, the former foreign secretary and mayor of London who has pledged to take the UK out of the EU on October 31, was elected as the next British prime minister succeeding Theresa May after winning the leadership of the ruling Conservative Party. His term will almost certainly be defined by Brexit, arguably the greatest political challenge faced by any British prime minister since World War II.

Market Observations

US Equities
July was a positive month for US equity markets. A flight to safety by investors worried about global growth, America’s trade war with China and now currency battle caused equities to fall in the early days of August. The consensus around second quarter growth in earnings per share has officially turned positive. The healthcare sector led the way with surprised earnings and growth. Healthcare companies in the S&P 500 saw 95% of reported earnings come in above estimates.

International Equities
International and emerging markets equities did not keep pace with US equities in July as both were slightly negative for the month. Given the tight trade relationship between China and developed international and emerging markets economies, additional stimulus implemented by China to prop up their domestic economy could be beneficial.

Fixed Income
The US 10-year Treasury ended the month at 2.0%. Since then, a flight to safety has resulted in yields falling dramatically. The current US 10-year Treasury yield sits at 1.7% as of date of writing. US credit indicators, specifically BBB spreads, look contained for now. Globally, negative yielding debt continues to rise and is nearing $14T in market value. The entire German government bond curve is in negative territory.

Real Assets
Global oil prices slid into a bear market. Brent crude has fallen more than 20% from an April high amid fresh concerns that the US-China trade war will hurt the global economy and curb fuel consumption. These concerns are in addition to the Middle East tensions between the US and Iran which may continue to keep oil volatility high as worries over global demand and growth expectations persist. In precious metals, the three main drivers of gold demand (portfolio diversification, inflation hedge and safe-haven assets) are currently buoying the recent price rally.

This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 8.19.19 and is subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford.

Investors Fight the Last War: Relative Value in Mortgage-Land

The recent past tends to bias our expectations of the future. Nobel Laureate Daniel Kahneman says it’s due to our reliance on what he calls the Representative Heuristic. Call it an evolutionary adaptation if you like, but long-term investors might as well call it opportunity.

History shows that investors and regulators collectively overestimate the likelihood of recent low-probability events repeating themselves following periods of market crisis. The visceral experience of gut-wrenching losses typically leads investors to abandon certain risk types leaving many assets orphaned and strategies hopelessly out of favor. The abandonment of the offending risk type in preparation for the “last war” often creates attractive investment opportunities for rational, margin-of-safety investors. The unmitigated disaster that was the mortgage debacle in the mid-2000s appears to have created just such opportunity in mortgage loans today.

The benefits of loan securitization were pushed way beyond any semblance of prudence in the early 2000’s driven by misaligned incentives at every step of the process (borrowers, originators, banks, securitizers, rating agencies etc.). The steady decline in borrower credit quality and deterioration in structural protections of mortgage backed securities were enabled by the nearly insatiable demand from the institutional investor community (insurance companies, bond funds, sovereign wealth funds, etc.). With subprime risk being the input, the credit derivatives market later metastasized into a series of increasingly leveraged side bets based on the dubious assumption that housing prices countrywide (pun intended) wouldn’t fall in value simultaneously. The sheer size of this ill-fated market sparked very real solvency and liquidity issues that had ripple effects throughout the entire global economy. This saga ended in tears as most market excesses tend to, and the reputation of the securitized credit market remains damaged to this day.

Driven by investor bias and substantial new regulation, many of the traditional providers of consumer credit have effectively exited the market following the financial crisis. This limited supply of willing lenders comes at a time when the US consumer’s creditworthiness is near all-time highs by many measures. The now fragmented non-agency mortgage market appears to offer attractive prospective returns with comparatively low risk relative to traditional stocks and bonds.

One example of an opportunity created by the aforementioned supply/demand mismatch is in investor mortgages. Post-crisis, it is exceptionally difficult to obtain financing to purchase a rental property, for example. The relative scarcity of funding is hugely advantageous to lenders with only the most creditworthy borrowers having access to such loans. These types of mortgage loans are well underwritten with low loan-to-value ratios, high debt service coverage ratios, fully verified borrower statistics and, in most cases, even personal guarantees from the borrowers. These conservative mortgage loans sporting relatively high interest rates represent a sufficient “margin of safety” in our estimation.

I can envision more than a few crisis-scarred readers scoffing at the idea of non-agency mortgages and mortgage backed securities being attractive, low risk investments. That’s exactly the mindset that allows such opportunities to persist! The below table highlights just how far the pendulum has swung in favor of conservatism in non-agency mortgage lending. It would now take a truly draconian scenario for investors in recent vintage mortgage pools to experience principal losses. For example, to impair even $1 of investor principal with loans issued at 67% loan-to-value, not only would the creditworthy borrower need to default, but the collateral backing the loan would need to decline in value by an amount 1.5x worse than the declines experienced in the global financial crisis1.

At Oxford we believe that embracing complexity and capitalizing on fragmented market segments are some of the surest ways to enhance client’s risk-adjusted returns. As noted above, these scenarios are often a direct result of increased regulations and irrational market participants preparing to fight the “last war.” The opportunities we currently see in mortgage-land are a prime example of a differentiated return source offering valuable diversification not often found directly in more pro-cyclical traditional (read “60/40”) asset allocations.

As seems to be true in most aspects of life, doing the difficult thing is often right. Investing is no different. Most market participants seem biased against digging through the wreckage following market traumas. Adding to recent underperformers is emotionally difficult, and often fraught with reputational risk. But it is often in these formerly challenging sectors where market imbalances produce the best risk-adjusted return opportunities.

1S&P/Case-Shiller 20 City Composite Home Price Index
2RCO 2018-VFS1 Trust
3Long Beach Mortgage Loan Trust 2006-1

The above commentary represents the opinions of the author as of 7.24.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.