Q2 2019 – Taxable Accounts Commentary

Posted on September 4, 2019

After faltering at the end of last year, U.S. and global markets have returned to a period of strong growth in 2019, with the S&P 500 returning 4.30% in the second quarter.  While this was considerably less than the first quarter’s return of 13.65%, due largely in part to markets rebounding sharply following a December selloff, the combined return marks the best first half-year performance for domestic markets since 1997.  Many trends from the first quarter continued through the second quarter, as mid-cap continued its outperformance and growth once again outperformed value. Growth has experienced a multi-year dominance, outperforming value YTD, as well as over the trailing one-, two-, and three-year periods.

Broadly speaking, international equities slightly underperformed their U.S. counterparts during the second quarter, though returns were predominantly positive across both developed and emerging markets.  When looking at the trailing one-, two-, and three-year periods, domestic markets have outperformed international by larger margins.

With a more dovish Federal Reserve hinting at looming interest rate cuts, fixed income markets posted relatively robust returns for the quarter.  Declining yields across all maturities played a major role in the positive quarterly performance. Longer-dated bonds continued to lead their shorter-maturity counterparts, with investment-grade issues largely faring better than high-yield offerings.  Municipal bonds underperformed their corporate equivalents, though minimal dispersion down the credit scale existed when compared to corporates.

Fidelity Go, SigFig, and WiseBanyan Portfolios Lead over Longer Periods

Looking longer term, Fidelity Go and SigFig continue to show strong performance over two- and three-year time periods when looking at the total return above/below the Normalized Benchmark.  Our Fidelity Go accounts do not yet have a three-year return, but have managed to lead in both total return above the Normalized Benchmark and equity performance over a two-year period, and placed third for equity performance in the one-year trailing time frame.  Fidelity Go’s lower-than-average international allocation has also helped their equities outperform. 

SigFig led the three-year returns, for both total returns above the Normalized Benchmark and equity-only performance, as well as placing second in the equity-only two-year return category.  Although their equity portfolio has a higher-than-average international allocation, they have a near equal weight between developed and emerging markets within international holdings. This is contrary to most portfolios we have observed, which hold far higher allocations in developed markets than emerging markets.  In the two- and three-year trailing time frame, emerging markets have outperformed developed markets, helping bolster SigFig’s performance. SigFig’s small allocation to emerging markets debt has also contributed to overall return.

WiseBanyan has also emerged as a consistent leader.  They placed in the top three for equity performance in the one-, two-, and three-year periods.  Like SigFig and Vanguard, WiseBanyan keeps its equity allocation simple; they use a single domestic equity fund and two international funds.  Additionally, they have an allocation to a REIT, which outperformed domestic equities YTD and over the trailing one-year period. WiseBanyan’s fixed income portfolio holds a large allocation to an investment-grade corporate bond fund that has helped strengthen their fixed income and total portfolio returns.

Equity: Value and International Underperforms

The amount of international holdings is one of the largest differences we see between our portfolios.  With strong domestic returns, those with larger allocations to international holdings have typically performed in the middle or bottom half of the group.  Morgan Stanley’s Active and Regular portfolios both hold more than half of their equities internationally. YTD, the Morgan Stanley Passive portfolio was one of the lowest performers compared to their Normalized Benchmark.  However, Morgan Stanley Active appeared to navigate general international underperformance over the year by using actively managed funds. Our Morgan Stanley Active portfolio was in the top ten for total return above/below the benchmark.

Another area that we see setting portfolios apart is whether they tilt toward value holdings.  Conventional wisdom has slightly favored value for a long time, but over the past three years growth has led.  Portfolios exhibiting a tilt toward value have lagged behind their peers during this period. For example, FutureAdvisor has a large-cap value fund combined with a neutral-weight fund in its domestic equity holdings, leading them to perform in the bottom half of portfolios when measured against its Normalized Benchmark for the one-, two-, and three-year periods.  Schwab’s portfolio holds 45% of equity internationally, which has held them back. Additionally, their portfolio holds a value tilt, which has contributed to their underperformance. 

Betterment is another portfolio with both larger-than-average international holdings and dedicated value exposure.  Last year they made tactical shifts to reduce both the amount of value and international, which was well timed. Their dedicated mid-cap exposure also helped level out their YTD performance.  Despite large international and value holdings, their performance has been around the middle of the pack across the time periods analyzed. Strong fixed income performance has also helped balance out poor performance in international funds.

Fixed Income Rewards Risk

During periods of persistently low rates and high confidence, those portfolios holding international, longer maturity, and corporate issues have been rewarded.  Schwab’s fixed income has held onto the top spot for three-year performance by taking a more risk-on approach. Holding high-yield and international debt has helped them over the long run. 

Ally Financial won the two-year fixed income category and placed second in the one-year.  Their portfolio holds longer-term maturities, a significant international fixed income position, and no dedicated short-term holdings, which led to their outperformance.  Betterment holds nearly half of their fixed income in international holdings, which has helped them perform consistently over different time periods. Large allocations abroad in their fixed income holdings have helped balance out the downward performance drag caused by large equity international holdings.  The amount of international holdings is one of the largest differences we see between our portfolios.

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