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Knowledge Center Archive

Apr
18
2012

First Quarter 2012 Market and Performance Update

By SEI Investment Management Unit

Summary

  • Investor confidence received a boost from continued central bank support in the U.S. and eurozone.
  • Equity markets gained, with risky assets among the strongest performers.
  • Bond market performance was held back by waning demand for government debt.

Equities rallied throughout the quarter, outperforming global bonds. Investor sentiment was generally positive and market volatility remained calm. Consequently, assets that are perceived to be riskier were favored. Measures by the European Central Bank (ECB) to support the banking system and progress toward resolving Greece’s sovereign debt troubles fueled a hopeful outlook.

Economic Backdrop

In January, the U.S. Federal Reserve (Fed) indicated that the country’s current low interest rates would continue until the end of 2014. This was longer than the markets had expected—the Fed had previously stated that interest rates would remain at near-zero until mid-2013. As such, the news was received positively.

Ratification of the second bailout package for Greece took place in the middle of the quarter. The deal, which was agreed to in 2011, provides €130 billion for Greece from the European Union and the International Monetary Fund. This helped to ensure that Greece would be able to avoid defaulting on its debt payment of €14.5 billion on March 20. However, the terms of the bailout were severe. One of the key conditions of the deal is that private sector Greek government bondholders need to agree to take a loss on what is owed to them. This will be achieved through a bond swap, also known as debt restructuring. The replacement debt would be worth less than the original, and would also pay interest at a lesser rate, equating to a 53% loss on a holder’s initial investment. Despite these terms and uncertainty surrounding the number of private investors willing to accept the losses, news of the agreement buoyed the markets.

Other activity in Europe also served to improve optimism during the quarter. The ECB introduced three-year loans—known as long-term refinancing operations (LTROs)—in January, with the intention of helping to ease short-term money-supply pressures on the region’s banks. This provision was welcomed by the markets at the start of the year and continued to have a positive impact in February and March as additional funding filtered through to banks.

Market Impact

Global bond markets as a whole rose marginally in the quarter, masking a large disparity between asset types. Government bonds generally fell out of favor as investors left “safe haven” debt to embrace risk. As a result, fixed-income assets that are perceived to be riskier performed strongly in the period. High-yield debt did particularly well, followed by emerging market debt. As demand for government bonds slowed, yields (which move inversely to prices) generally rose. Investor concern about the debt crisis in the eurozone lessened during the period and, in response, the government debt of most peripheral eurozone countries outperformed that of core eurozone countries. Spain was a notable outlier. Spanish 10-year government bond yields ended the quarter higher than the 10-year benchmark yield of Italy, signaling renewed concerns over the Spain’s finances (the country slipped back into a recession and unemployment remains among the highest in the region) and upcoming reforms (future austerity measures and a violent public demonstration at the end of March).

Central bank support and more positive investor sentiment drove a positive quarter for the equity markets. Volatility declined and correlations fell sharply to the point that stocks no longer all moved together. Valuations in the equity markets ended the quarter more in line with company fundamentals. In this environment, investors favored riskier assets. In the equity markets, cyclical sectors performed well. Information Technology (IT), Financials and Consumer Discretionary recorded the highest returns, while more defensive sectors lagged. Small-company stocks outperformed mid-size and large companies for the period, and emerging market equities beat developed.

Index Data

  • The Dow Jones Industrial Average index gained 8.84%.
  • The S&P 500 Index returned 12.59%.
  • The NASDAQ Composite Index increased 18.97%.
  • The MSCI AC World Index, used to gauge global equity performance, gained 11.88%.
  • The Barclays Capital Global Aggregate Index, which represents global bond markets, rose by 0.87%.
  • The Chicago Board Options Exchange Volatility Index (VIX), a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” fell from 23.40 to 15.50.
  • WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $98.83 a barrel at the end of December to $103.02 by March 30, and reached a high of $109.49 in mid-February.
  • The Japanese yen weakened against most currencies, as did the U.S. dollar, which fell against the euro and sterling, but gained against the Japanese yen. The Swiss franc strengthened, while sterling and the euro were mixed. The U.S. dollar ended March at $1.59 against sterling, $1.33 versus the euro and at 82.29 yen.

Portfolio Review

SEI’s equity portfolios benefited from investor exuberance in the first quarter. Although this waned somewhat in March, strong results in January and February were enough to deliver positive returns for the period. In large-cap equity, solid stock picking within and an underweight to Consumer Staples were the largest contributors to performance. In small-cap equity, stock selection within the IT and Industrials sectors contributed nicely to results. In international equity, overweights to small- and mid-cap stocks and an underweight to mega-cap stocks had a positive impact on performance.

SEI’s high-yield and emerging markets debt fixed-income portfolios performed particularly well during the quarter as a result of investor sentiment favoring riskier assets. In core fixed income, a short duration posture had a positive impact, as did an overweight to commercial mortgage-backed securities. An allocation to collateralized loan obligations (CLOs) added to performance in high-yield debt, as CLO prices caught up with the strong returns of the high-yield bond market due to improved liquidity, strong demand and solid fundamentals. In emerging markets debt, a diversified list of credits across various sectors and countries—especially in Brazil and Russia—was responsible for strong performance.

 Contributors

  • Overweight to IT in Large-Cap Equity – hardware and equipment provided a significant boost in this sector
  • Pro-Cyclical Bias in Small-Cap Equity – this generally helped performance as beta and growth exposure were tailwinds
  • Stock Selection in International Equity – picks in the Industrials sector more than offset weak selection in Consumer Discretionary
  • Overweight to Venezuela in Emerging Market Debt – an increase in support for the opposition party against Hugo Chavez supported this area 

Detractors

  • Underweight to Financials in Large-Cap Equity – this mitigated the positive impact of solid stock selection in the area
  • Consumer Discretionary Picks in Small-Cap Equity – these proved challenging as the consumer economy tried to find its footing.
  • Regional allocation in International Equity – holdings in emerging markets and Canada detracted from performance
  • Underweight to Banking in High-Yield Debt – this sector produced the best quarterly return following the announcement of the ECB’s LTRO  

Manager Positioning and Opportunities

SEI’s portfolio managers aim to provide diversified sources of excess return for our portfolios through solid investment-manager selection and portfolio construction. In large-cap equity, managers have maintained a slight growth bias and overweights to IT and Consumer Discretionary, as they believe an attractive opportunity set is still present in these areas. In small-cap equity, managers are maintaining a pro-cyclical bias, which is reflected in overweight positions to Industrials, IT and Energy, along with underweight positions to Utilities and Consumer Staples. International equity managers feel an underweight to Europe is appropriate because there is still a chance for further disruption from the area, such as Greece unexpectedly leaving the eurozone

In investment-grade fixed income, we expect managers to continue to tactically trade agency mortgage-backed securities given the dislocations created by perceived and actual government policy. Underweights to the Energy and Utility sectors are likely to remain in high-yield debt, as they both have a number of large, high-quality issuers which managers feel are fully valued at this point in time. In emerging market debt, managers still like both corporate and local currency debt, but have reduced local currency exposure given the strong start to the year and the still uncertain global growth environment.

Our View

We are neutral on equities versus bonds. Although we believe equities are likely to experience a period of pullback and consolidation in the months ahead, we do not expect a severe reversal like the one experienced last year. SEI believes that U.S. economic expansion is finally on firmer ground. Although earnings growth will continue to ease as margins decline from the abnormally high levels achieved in recent years, the improvement in the financial position of U.S. households and the recovery in employment should give investors confidence that U.S. economic expansion will be sustained.

We favor U.S. versus international equities, as the U.S. certainly looks like the best house in a bad neighborhood. Although the eurozone has made some progress in dealing with its periphery debt crisis, it will continue to face periods of stress. Growth in the strongest countries is likely to trail the U.S., while problem debtors continue to face austerity-induced economic decline. Eurozone exporters may benefit if the euro declines as we expect. Emerging markets will likely continue to grow at a faster clip than the U.S., but China, India and Brazil all have issues that lessen their near-term attractiveness.

We favor high-yield debt versus investment-grade fixed income. The financial health of high-yield debt issuers suggests that this asset class should continue to outperform Treasurys and investment-grade bonds.

 Glossary of Terminology

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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.

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.

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