KNOWLEDGE CENTER

Knowledge Center Archive

Oct
18
2012

Third Quarter 2012 Market and Performance Update

Summary:

  • The financial markets were once again dominated by events in Europe and concerns about the global economic outlook, but central-bank actions helped to bolster investor sentiment.
  • Market activity and trading volumes slowed at mid-quarter due to the summer holidays, pushing volatility to lows unseen for several years.
  • Global equities and bonds both experienced gains in the quarter, with equities pulling ahead as riskier assets returned to favor.
  • Within fixed income, emerging-market debt and high-yield bonds did best.

Economic Backdrop

Leading central banks became even more accommodative in the third quarter as part of ongoing efforts to stimulate global growth. The European Central Bank (ECB) lowered the key eurozone interest rate to a record-low 0.75% in July. This is the rate banks pay when they borrow money from the central bank. The central bank also reduced the deposit rate it pays to banks when they make overnight deposits to 0%. This stance was maintained in August and September. Investor sentiment notably improved after ECB president Mario Draghi’s reassuring statement on July 26. Draghi reiterated a collective drive to support the eurozone, assuring that the ECB would do “whatever it takes.” His later pledge to introduce the Outright Monetary Transactions (OMT) program further improved the mood. The OMT program enables the ECB to purchase unlimited quantities of the sovereign debt of troubled nations in order to limit their borrowing costs. These purchases will be conditional upon economic reforms and limited to government securities in the one-to-three year maturity range.

The Bank of England voted to maintain interest rates at the historic low of 0.50% throughout the quarter, although the committee acknowledged the need for further stimulus measures in the U.K. It also agreed to expand the scope of the asset purchase program by a further £50 billion in July. Under this initiative, the bank creates new money and uses it to purchase government bonds (gilts) and high-quality corporate bonds in attempts to keep interest rates low and encourage spending.

The U.S. Federal Reserve (Fed) also kept interest rates low and announced that it was greatly expanding its bond purchasing program by buying up to $40 billion of agency mortgage-backed securities on a monthly basis, with no predetermined end date. However, optimism regarding the near-term economic outlook continued to fade in the U.S., as the fiscal cliff ($600 billion of tax increases and spending scheduled to take place at year end) appears likely to restrain growth in 2013.

Market Impact

All areas of the fixed-income market performed well during the quarter courtesy of ECB actions (notably Draghi’s July statement and the announcement of the upcoming OMT program) combined with the commitment of central banks around the world to keep interest rates low. Emerging-market debt performed best for the period and high-yield bonds outperformed investment-grade corporate bonds. Government bonds brought up the rear. Within Europe, the sovereign bonds of peripheral eurozone countries rallied. Spanish and Italian government bond yields rose while prices fell. Those with short maturity dates moved the most, as the ECB has raised the prospect of substantial support through purchases at the short end of the maturity range.

The equity market rally that began in June continued throughout much of the third quarter. The prospect of further stimulus/supportive measures on behalf of various central banks helped stock markets to rise in the period. This was particularly the case for the European equity markets, which were among the best-performing for the quarter. Germany and Spain did particularly well and generated strong returns, although Greece continued to lag. Emerging-market equities also performed well. Within the MSCI AC World Index, all sectors were positive for the quarter (in U.S. dollar terms), with riskier stocks outperforming. While there was no strong preference for cyclical stocks or defensive stocks, the Energy, Financials and Healthcare sectors performed best.

Index Data

  • The MSCI AC World Index, used to gauge global equity performance, gained 6.84%.
  • The Barclays Global Aggregate Index, which represents global bond markets, rose by 3.27%.
  • The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” moved from 17.08 to 15.73, but went as low as 13.45 on August 17.
  • WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $84.96 a barrel at the end of June to $92.19 by September 30.
  • The U.S. dollar weakened against most major currencies, while sterling strengthened. The U.S. dollar ended September at $1.61 against sterling, $1.29 versus the euro and at 77.80 yen.

Portfolio Review

Equities posted respectable gains during the quarter as investor sentiment once again favored risk as central banks expanded their accommodative monetary policies and Europe made some strides towards resolving its debt crisis. For large-cap equity, stock selection within the Energy sector was the largest single contributor to relative outperformance, followed by selection within Financials and Materials. An underweight to Utilities also generated alpha. Conversely, picks within Consumer Discretionary and Health Care were the largest detractors. In small-cap equity, sector-allocation decisions slightly detracted from performance and individual stock selection was a headwind. The portfolio added value in three of ten sectors, but only modestly so. In Health Care, an overweight position in equipment and services was helpful, but stock selection was poor across the entire sector. For international, stock selection was positive in Japan and the U.K. The portfolio also benefitted from its underweight to Japan and ex-benchmark allocation to Canada, while an underweight to Australia hurt results somewhat. At the sector level, strong selection in Energy, Materials, and Industrials overcame the negative effects of an underweight to the Financials sector. Emerging-markets results were mixed, with strong stock selection in Industrials and Materials but weak selection in Consumer Discretionary and Health Care.

In core fixed income, overweights to commercial mortgage-backed securities (CMBS) and financials were positive contributors to performance, while a curve-flattening position detracted from performance as the 30-year Treasury yield rose (price fell) and the curve steepened. High yield benefited from collateralized loan obligations (CLO) which enhanced relative performance, as investors continued searching for investments with attractive yields. Subtracting from performance was an underweight to and security selection in the outperforming Banking sector. Internationally, a short-duration position was positive as was an underweight stance to sovereigns both in terms of market-value and duration. The underweight stance to covered bonds detracted as this sub-sector outperformed the benchmark. In emerging-market debt, an overweight to higher-yielding credits and an increase to local foreign exchange rates during the period benefitted returns. In Mexico, an overweight to local debt and an underweight to external debt both added as the peso rallied while external bonds lagged.

 Contributors  Detractors
  •  Large-Cap Equity – strong stock selection in Energy, Financials and Materials sectors
  • Small-Cap Equity – stock selection in Consumer Staples, Energy and Consumer Discretionary
  • International Equity – Energy, Materials and Industrials selections outperformed
  • Emerging Markets Equity – selections in Industrials and Materials
  • Core Fixed Income – CMBS and financials
  • High Yield – collateralized loan obligations
  • International Fixed – short duration, underweight sovereigns
  • Emerging Markets Debt – overweight to higher-yield debt and local-currency-denominated bonds
  • Large-Cap Equity – stock selection in Consumer Discretionary
  • Small-Cap Equity – Health Care, Industrials and Financials picks
  • International Equity – underweights to Australia and the Financials sector
  • Emerging Markets Equity – Consumer Discretionary and Health Care picks
  • Core Fixed Income – curve-flattening position
  • High Yield – underweight to and selection in banks
  • International Fixed – underweight covered bonds
  • Emerging Markets Debt – overweight to local debt and underweight to external debt in Mexico as peso rallied

Manager Positioning and Opportunities

SEI’s portfolio managers rely on investment-manager selection and portfolio construction in an effort to deliver diversified sources of excess return for our portfolios. In large-cap equity, investment managers maintain overweights to Information Technology and Consumer Discretionary while remaining underweight Industrials, Utilities and Financials. For small-cap equity, the largest underweight positions are in Utilities and Materials, though the underweight to Materials was narrowed during the quarter. It is also light on exposure to Financials, mostly due to a meaningful underweight in the capital-markets segment. Internationally, the portfolio has positions in resource-rich Canada, since commodity prices are likely to rise with inflation, and emerging markets, as we still see these as the primary source of future global growth. In contrast, SEI is underweight to the aging economy of Japan, although our managers continue to employ shrewd stock selection to uncover pockets of strength in that country.

In investment-grade fixed income, duration was shorter than the benchmark at the end of the quarter, given the low level of Treasury yields and negative real yields. Spread-sector allocations continue to be focused on the securitized sectors as they represent the greatest fundamental relative value. High-yield positioning maintains a slightly defensive posture through an increased allocation to loans, a reduction in CCC-rated bonds and credit default swap positioning. Within international bonds, the portfolio is overweight corporate bonds, especially industrials and financials, as the managers believe that spread risk still has a positively skewed reward-to-risk ratio. Emerging-market-debt exposure to local-currency markets is being increased as a result of more attractive valuations (both absolute and relative) as yields on dollar debt continue to decline to record lows.

Our View

From an investment positioning standpoint, we have adhered to a neutral stock-bond view in terms of asset allocation, maintaining parity between our strategic (long-term) allocations and our active (short-term) allocations. Equities have appeared to be extended in a short-term sense, and we have anticipated that some consolidation would occur. That pullback did not occur in the third quarter, thanks to the forceful actions taken by the Fed and the ECB. There are, however, some make-or-break events that could still cause turmoil in financial markets. The Greek government, for example, needs to get another tranche of bailout money in October, or it will likely default on its debt obligations. In the U.S., politicians need to deal with the fiscal cliff that kicks in on January 1, 2013, with the price of failure a possible U.S. recession. Meanwhile, China’s economy continues to show signs of wear and tear, hurt by the slowdown in trade with Europe and a diminishing cost advantage versus other emerging-market competitors.

While it may be hard to judge how markets will move in the months immediately ahead, we do have more confidence in some longer-term themes. We favor investment-grade credit and high-yield bonds over government bonds within the fixed-income space. Within equities, our longer-term inclination is to go where the relative growth is. That implies an emphasis on the U.S. and emerging markets over developed Europe.

Glossary

The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 blue-chip New York Stock Exchange stocks which are selected by editors of the Wall Street Journal.
The S&P 500 Index is a capitalization-weighted index made up of 500 widely held large-cap U.S. stocks in the Industrials, Transportation, Utilities and Financials sectors.
The NASDAQ Composite Index is a market-value-weighted index of all common stocks listed on the National Association of Securities Dealers Automated Quotations (NASDAQ) system.
The MSCI All Country World Index is a market-capitalization-weighted index composed of over 2,000 companies, and is representative of the market structure of 48 developed and emerging market countries in North and South America, Europe, Africa, and the Pacific Rim. The index is calculated with net dividends reinvested in U.S. dollars.
The Barclays Capital Global Aggregate Bond Index (formerly Lehman Brothers Global Aggregate Index), an unmanaged market-capitalization-weighted benchmark, tracks the performance of investment-grade fixed- income securities denominated in 13 currencies. The index reflects reinvestment of all distributions and changes in market prices.
The Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 over the next 30 days. A higher number indicates greater volatility.

# #

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There is no assurance as of the date of this material that the securities mentioned remain in or out of SEI Funds.

For those SEI Funds which employ the ‘manager of managers’ structure, SEI Investments Management Corporation (SIMC) has ultimate responsibility for the investment performance of the Funds due to its responsibility to oversee the sub-advisers and recommend their hiring, termination and replacement. SIMC is the adviser to the SEI Funds, which are distributed by SEI Investments Distribution Co. (SIDCO). SIMC and SIDCO are wholly owned subsidiaries of SEI Investments Company.

To determine if the Funds are an appropriate investment for you, carefully consider the investment objectives, risk factors and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which can be obtained by calling 1-800-DIAL-SEI. Read them carefully before investing.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. 

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.

  • Not FDIC Insured
  • No Bank Guarantee
  • May Lose Value