Displaying items by tag: underperformance
Long-dated Treasuries' Bad Year Likely a One-off
When stocks are down like they were last year, investors usually look towards treasuries for safety. But last year was unlike any other year. While the S&P 500 fell 18%, the Bloomberg U.S. Aggregate Bond index slumped 13%. However, a year like 2022 is unlikely to happen again any time soon. According to analysts, that leaves “room for those bonds to reclaim their role as a core risk-off allocation for asset owners this year.” For example, when SVB Financial Group recently announced hefty losses, the S&P 500 index fell 3.4% between March 8th and March 13th. But investors looking for a safe haven in long-dated Treasuries sent yields plunging, providing bondholders with a gain of more than 4%. Many analysts expect the conditions that led to close correlations between the stock and bond market “to prove ephemeral.” According to Jason Vaillancourt, global macro strategist with Putnam Investments, the biggest risk for those strong correlations is when "The Fed gets really fired up to fight inflation, as with the central bank's 'uh-oh' moment last year — when inflationary pressures it had deemed transitory proved anything but, forcing the central bank to shift aggressively to catch-up mode.” He added, “With the Fed frontloading its fight against inflation last year, the conditions required to maintain correlations at 1 this year are unlikely to persist.”
Finsum:With the Fed front-loading its fight against inflation last year, the conditions that led to a high correlation between the stock and bonds markets, aren’t likely to persist.
Active Fixed Income Management Fees Drop After Poor Performance
According to Investment Metrics' most recent fee analyzer report, active management fees dropped last year after underwhelming returns. U.S. fixed-income managers saw the largest reduction in fees, with a 7% average annual cut. In fact, post-negotiated fees for active managers decreased in most categories last year. The report was based on the analyses of almost 490 distinct accounts and co-mingled funds. According to Investment Metrics, the fee reduction trend appears to correspond to poor performance of active managers as most categories fell short of beating their standards. Scott Treacy, a research consultant at Investment Metrics, wrote the following in the report, “Normally, the fixed-income asset class protects investors when equity markets crater, but that did not happen in 2022.” He added, “Active U.S. fixed income disappointed in particular. Unfortunately, at a median level, active managers were not able to perform well in this environment.” While active managers had a chance to demonstrate that their expertise could shield portfolios during the downturn, the underwhelming results may put greater pressure on active strategies. Treacy concluded that “Those active managers that were not able to perform in the down market of 2022 will most likely see their assets go to passive strategies, or to other active managers that performed well in this difficult environment.”
Finsum:Active management fees dropped last year after managers produced underwhelming returns, with U.S. fixed-income managers seeing the largest reduction in fees.
Impact of ESG Strategies on Expected Returns
Investors have continued to pile into ESG funds amid a strong political backlash and new regulations, but what impact does ESG have on expected returns? In their book, Your Essential Guide to Sustainable Investing, Larry Swedroe, and Sam Adams presented the answer to that question from research that included studies from 2017, 2018, 2019, 2020, and 2021. They found that in both U.S. and international markets, ESG strategies’ returns were well explained by their exposures to the Fama-French factors of market, size, profitability, investment, momentum, and value; and multifactor alphas were not significantly different from zero. This indicates that any benefit from incorporating ESG strategies into a portfolio is already captured by other well-defined and known equity factors, meaning investors could not improve their Sharpe ratios by using ESG strategies. They also found that return and risk differences of ESG funds could be significant and were mainly driven by fund-specific criteria rather than by a homogeneous ESG factor. In addition, across four fund categories including index, active, exclusion-based, and non-exclusion based, the majority of observations displayed higher volatility than the broader market. Swedroe and Adams also noted that environmental and social scores did not contribute to performance. However, if investors want to have their cake and eat it too, then they should tilt their portfolios to sustainable firms with exposure to the Fama-French factors of size, investment, profitability, value, and momentum.
Finsum:In their book, Your Essential Guide to Sustainable Investing, Larry Swedroe, and Sam Adams presented evidence that ESG strategies don’t provide any return benefit unless they’re tilted to Fama-French factors of market, size, profitability, investment, and momentum.
ESG Performance in 2023 May Depend on Oil
While ESG has continued to come under fire from both politicians and regulators, ESG fund assets have continued to grow. In fact, sustainable fund assets grew 0.84% through November, which is better than the 1.1% decline for all funds, according to Morningstar. However, the performance of these funds has not been great; but that's not due to political or regulatory pressure. According to analysts, the reason that ESG funds have underperformed this year is that they missed out on the best performing sector this year, which was energy. ESG funds typically don’t hold stocks of oil companies such as ExxonMobil and Chevron that have performed so well this year. According to Morningstar, the average large-cap stock ESG fund has lost nearly 20% through Dec. 21st. That’s about 2.4% worse than the S&P 500 Index. The question is, will that continue into 2023? The answer depends on whether oil companies will continue to outperform. Energy strategists differ in their opinions. Morningstar energy strategist Stephen Ellis thinks it’s unlikely, since “we see the stocks as fairly valued to expensive,” while Fidelity portfolio manager Maurice Fitzmaurice wrote recently “that oil and gas demand should keep growing as effects of the Covid pandemic pass, while lost supplies from Russia prod oil prices to rise.”
Finsum:The performance of ESG funds next year will likely depend on whether oil companies will continue to outperform.