1st Quarter Client Note

The S & P 500 (Total Return) Index gained 1.35% in the quarter. This was no mean feat considering what was occurring in January. The first two weeks of January welcomed the worst start to a year for the S & P 500 in history. The index was down 7.93% from January 4 -15. For the month, the index lost 4.96%, the ninth lowest since 1926.

On February 10, The Wall Street Journal asked What’s Going on in the Markets? – and offered 5 theories to explain the chaos: 1) low interest rates, 2) continued devaluation of the Chinese Yuan, 3) slowing global growth, 4) falling oil prices and 5) sovereign wealth funds. Regardless of what you might have then attributed the volatility to, the most important thing was to understand that such short term moves in the market are fairly normal and that historically there is no correlation between what happens in January (or any particular month) and what takes place in the remainder of the year. As for bear markets in general, between 1926 and 2015 there have been 152 declines of 10% and 39 declines of 20%. Following each of these declines the average annual compound return for the following 5 years has been approximately 10%.

All of this highlights the critical importance of maintaining discipline in the face of tumult in order to capture the expected returns of the markets. Speaking of discipline, in the Quarterly Topic at the end of the Quarterly Market Review from our friends at Dimensional Funds Advisors, there’s a nice discussion of the parallel between the process and discipline required for an athlete to perform under stress and the similar attributes for investors to succeed in the topsy-turvy world of the investment markets.

Value Rebounds

From 1928 – 2015 the value premium (the average amount by which value stocks have outperformed growth stocks on an annual basis) has been 3.44%. However, for going on a decade now, value stocks have been underperforming growth stocks and therefore, by definition, underperforming core (the blend of growth and value) as well. For investors like us, who tilt toward value stocks on the historical understanding that value stocks have higher expected returns – over time – this has been a trying time. And this is not the first such extended period of underperformance.  But maybe the value premium is awakening. In the quarter US Large Cap Value outperformed Large Cap Growth by .90%. US Small Cap Value outperformed Small Cap Growth by 6.38%. Whether this is the beginning of a long term trend remains to be seen. But this is certainly another example of the need for patience for investors who want to capture market premiums.

Other Asset Classes

For the first time in a long while, emerging markets had a strong quarter; with the MSCI Emerging Markets Index up 5.71%. Real Estate gained over 5% as well. With interest rates generally falling, bonds performed well. The Barclays US Aggregate Bond Index gained 3.03%

Fiduciary Fandango

As you may have read, on April 6, the US Department of Labor announced a rule requiring anyone offering advice on retirement accounts, including on 401k’s and IRA’s, to act as a “fiduciary” – i.e., in the client’s best interest. In some quarters of the financial services industry, particularly for brokerage firms and their representatives, this is a revolutionary advancement.

Brokers, in general, up until now, have been held to the lesser “suitability” standard in dealing with their customers; still able to have conflicts of interest so long as the investments recommended are not inappropriate. For Registered Investment Advisers, like RightPath, this is almost a non-event; since we are legally a fiduciary anyway and have always been required to act in our client’s best interest. And we earn our compensation via what the new rule describes as “level fees” in which: 1) our compensation cannot be influenced by commission amounts which may differ depending on which product is recommended or 2) influenced by payments from third parties other than the client. But this certainly is a welcome development because many investors still work with brokers.

A Few Details

For starters, the new rule, which goes fully into effect on January 1, 2018, only applies to retirement accounts, over which the DOL has jurisdiction along with the IRS. So investors working with brokers on their regular taxable brokerage accounts still need to be watchful for investment recommendations that might not be up to the new standard; at least until the SEC acts to close the gap.

The rule provides that brokers advising on 401k’s and IRA’s can no longer earn commissions unless pursuant to a written Best Interest Contract under which the broker: 1) discloses all material conflicts of interest, 2) commits to the new fiduciary standard and 3) discloses all compensation – which must be reasonable.

Technically, it will still be possible for brokers to sell controversial products into retirement accounts – such as high-fee annuities, proprietary products, non-traded REIT’s and expensive actively managed mutual funds. But brokerage firms may still be faced with the task of defending these products as being in the client’s best interest in a class action lawsuit filed by a plaintiff’s attorney.

Typical Pushback

The new rule was issued over strenuous objection from the brokerage and insurance industries, both of which are threatening to sue the Obama administration to prevent it from going into effect. But hopefully the courts will uphold this regulation in spite of it being the kind of thing the Chamber of Commerce hates. It may just make the difference in whether hundreds of thousands of Americans can afford a secure retirement.

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