Report from the CIO

“Fund Management remains focused on both setting a thoughtful asset allocation that balances the collection of risks we accept as well as carefully selecting and sizing a range of strategies and managers.


Fiscal Year 2017:
A Strong One for the Fund

The Fund experienced a year of strong performance in fiscal year 2017, earning returns of over 13%, net of all manager fees and internal investment costs. This occurred in a period during which many financial markets performed well, with several recording double-digit returns.

  • Equity markets performed particularly well in FY 17. While the S&P 500 in the US did nicely, rising 18%, international developed markets gained nearly 20%, while emerging market equities advanced approximately 24%. These international markets reversed the pattern of the last few years, during which they lagged behind US equity markets.

  • FY 17 presented a stark contrast to most of FY 15 and FY 16. Following a long period of strong results (FY 13 and FY 14), in an almost biblical pattern, we endured seven fallow quarters (spanning much of FY 15 and FY 16). This has been followed by a bountiful harvest of returns, which began toward the end of FY 16 and continued through FY 17 and now into early FY 18.

  • While the Fund has exposure to many markets globally, our portfolio—and, hence, our performance—is meaningfully affected by how equity markets behave. Management is looking to modify this to some degree going forward, but we expect that equity markets will continue to be an important influence on the Fund’s returns.

Earnings Growth and Economic Growth Improved

Many factors influenced how markets performed over the last year, but two were primary: the interrelated changes and improvements in earnings and economic growth, and the continued outlook for each. Other contributing factors include the level of interest rates and the shape of the yield curve, subdued inflation, improving employment data, manageable corporate debt levels and more available credit, muted volatility, money flows, investor optimism, and expectations regarding how central bankers would conduct monetary policy.

In the US, aggregate earnings for the S&P 500 virtually flatlined at ~$118 per share for the last three years, but are expected to exceed $130 per share in 2017. Similar patterns of earnings growth appeared in the Stoxx 600 in Europe and the Nikkei 225 in Japan. Whereas earnings picked up ~10% after seven flat-to-down quarters in the US, corporate earnings in Europe grew 20% year- on-year, and in Japan, they increased by 25%. Optimism exists for continued improvement.

Of course, earnings growth relates to economic growth. The latter has picked up, and many of the fears of recession (or worse) in China, Japan, Europe, and even in the US, have not been realized. Furthermore, expectations as to when economic growth might slow have been pushed out a year or more. In the US, recession does not seem to be imminent despite eight years of economic growth. Inflation remains persistently low globally, and a key cause is the impact of deflationary and disruptive technologies, which central bank stimulus has not been able to overcome.

Economic growth expectations began to increase towards the middle of calendar year 2016, and interest rates domestically began to rise in concert. The combination of Republicans gaining control of the White House and both congressional chambers last November led to an accelerating rise in interest rates on the backs of expectations of better economic growth and the hope that changing leadership in Washington would lead to positive change in the economy and in earnings.

In the six months since leadership in Washington changed hands, there have been some changes on the regulatory front in a few industries, but little actual progress has been made in several of the most important legislative matters that were expected to drive further economic (and earnings) growth. In fact, the stocks that led to the so-called “Trump Bump” following the election have, on the whole, retraced their entire gain (which some have labeled the “Trump Dump”) and now stand around the levels of early November. Four of the five best-performing S&P 500 sectors in the last two months of 2016 underperformed the S&P 500 in the first six months of 2017. The US dollar has followed suit, strengthening after the US election but weakening thus far in 2017.

Nevertheless, equity market indices have continued to advance. There remains hope that the arrival of legislative changes, continued regulatory relief, and lower tax rates (if not broader tax reform) have merely been delayed. We seem to be in a protracted period in which the economy is growing, but not so fast as to require steep Fed interest rate hikes. This so-called Goldilocks environment (not too hot, not too cold) has spurred money flows into equities, leading to strong share price appreciation with only modest multiple expansion, although from high levels.

Outlook for Financial Markets

Complacency seems to define the current attitude of market participants across financial markets around the globe. Investor behavior suggests that there will continue to be (a) moderate levels of economic growth; (b) macroeconomic stability (as even the troubled and overleveraged countries stabilize); (c) contained inflation (albeit at levels lower than preferred by central bankers); (d) muted volatility (as central bankers seemingly continue to stand ready to provide support); and (e) low interest rates (even if above the levels of recent years). All of these aspects will lead to continued gains from already high price levels for equities, bonds, real estate and, indeed, most asset classes.

Financial stability begetting sound financial returns begetting complacency can be self-reinforcing. Complacency can endure for a long while, until it does not. Often, inflation or recession causes a reassessment. Occasionally, it is a major geopolitical event that causes this. Fund Management is uneasy about the state of affairs, even as we reap the benefits of rising markets.

From here, appreciation in equity markets, if it continues, will likely need to occur during a period of rising short-term interest rates. Most of the major central banks have begun to publicly discuss their expectations for raising rates amidst (1) sustained, albeit low, economic growth and (2) diminished political risks, particularly in Europe. The European Central Bank has responded by making more hawkish comments than it has in quite a while. Closer to home, the Federal Reserve has discussed not only continuing to raise policy rates but also beginning to reduce its rather large balance sheet holdings of securities.

The Fed and the bond market have largely been in step. Stability in financial markets may depend meaningfully on this remaining the case as the Fed begins its securities unwind. If the two were to become meaningfully out of step, the positive investor outlook and muted volatility that has accompanied and reinforced the equity market rise could be compromised.

Highlights of Fund Performance (Net of All Investment Costs)

Highlights Fund PerformanceThe Fund takes a long-term perspective in its asset allocation and investment decisions as well as in evaluating performance. We summarize our fiscal year results in each Annual Report. In FY 17, a year of strong returns in the investment markets, the Fund performed quite well, gaining 13.3%, net of all investment costs. We ended with $6.6 billion of assets.

To gain a sense of how our portfolio is performing, the Fund has created a composite benchmark that is a best estimate of the types of risks we are willing to accept and types of exposures we are trying to have. The Fund has underperformed its composite benchmark in only one of the last eight fiscal years and has exceeded this metric over the last three, five, and seven years. The 10-year numbers do not compare favorably due to the weak relative performance during the Great Financial Crisis. Changes made since then to the Fund’s asset allocation, exposure measurement and risk management make such a degree of underperformance unlikely, all else equal. 

​​Annual Fund Performance

However, we would note that the Fund has intentionally begun to gain increased exposure to strategies that differ meaningfully from those of the Fund’s benchmarks. This is being done to generate superior absolute returns over time and is essential for the Fund’s continued success and ability to both enhance our funding level and award sustained higher interest credits.

While we expect that, over most relevant time periods, the Fund would continue to outperform its benchmarks—and by greater amounts than in the past—there will be years and even multiyear periods when the Fund will underperform its benchmarks, perhaps by a few hundred basis points. Fund Management, with the support of Trustees, has elected to accept greater short-term variance from its benchmark in return for higher expected absolute returns over a cycle.

Performance Net Table


The Fund performed positively on both an absolute and relative basis over the benchmark this year. However, we caution that the investment strategies we pursue are not expected to provide positive returns or better returns than a given benchmark every single year. Rather, we select these strategies to provide the long-term returns necessary to support Fund benefits. While we pay close attention to interim results and make course corrections along the way, our ability to take a long-term perspective is one of the Fund’s key investment advantages.

Assets that had been a drag on performance in FY 16 led performance in FY 17. The Fund’s overweight allocation to Public Equity drove the strong performance on both an absolute and relative basis. Strong manager selection in the US and Emerging Markets was a large contributor to this outperformance.

The Fund outperformed its benchmark in FY 17 by 163 basis points, further increasing our positive absolute and relative returns over longer periods.

Investment Strategy

Management continues to take several steps to fulfill the Fund’s mission in the face of a challenging environment of elevated valuations for nearly all asset classes. Historically, about half of the Fund’s exposure has been to public equities, particularly US equities, which has served us well during this bull market. However, as we enter the ninth year of continued economic expansion in the US, the Fund has begun to reduce US long-only equity exposure. To be clear, public US stocks are currently the Fund’s largest exposure, and we expect they still will be—just less so. Instead, we will be allocating more to private equity ownership in its many forms, including buyouts, growth capital, venture capital, real estate, and equity in oil and gas-related opportunities. Most of these will likely continue to be US-based.

We also plan to increase our international public equity ownership, as Management believes that we can garner more attractive market returns (betas) in certain non-US markets than in US ones, as well as have a greater ability to generate better-than-market returns (alpha).

Asset Pies

We continue to pursue return streams that are less correlated to both economic growth and financial market valuations, which are some of the main factors that drive equity values. Steps we have taken to accomplish this goal include the following:

  • Increasing our allocation to certain Diversifying Strategies that are not highly correlated to public equities and that we expect will produce attractive (or at least acceptable) long-term returns; these types of exposures, taken as a whole, can comprise a portfolio that retains value or appreciates during periods of equity market distress

  • Increasing our allocation to certain alternative Directional Strategies; this includes private equity managers, activist investors or certain hedge fund strategies that pursue attractive absolute returns with mitigated risk

  • Maintaining exposure to US government securities in our Rates portfolio

  • Continuing to allocate to assets with differentiated risk factors, such as in the Credit, Real Estate and Natural Resources portfolios

Asset Class Exposures

Public Equities - As the largest single asset class, representing over 40% of the Fund, Public Equities plays an important—dominating, even—role in both the Fund’s return generation and volatility. Management selects investment firms that perform deep diligence on their portfolios (and some that occasionally use activist strategies to enhance returns), while also paying close attention to how their companies would perform in an economic downturn. In general, we tend to prefer investing with valuation-sensitive equity managers who perform in-depth analyses of the underlying businesses and their competitive positioning. However, the Fund remains broadly diversified across geographies, sectors, investment styles, and other metrics.

Rates - We expect the Rates portfolio to provide liquidity and downside protection, with return generation being a lower priority. As such, this asset class is currently comprised solely of US government obligations. However, in some circumstances, it might hold other low-risk assets.

Credit - The Credit portfolio consists of managers who pursue an array of strategies, including distressed investments, senior secured bank loans, direct lending funds, and funds that invest opportunistically throughout the credit universe. These funds seek to generate strong long-term returns, and security selection tends to affect returns more than interest rate movements do.

Directional Strategies - The objective of the Directional Strategies portfolio is to produce a return stream that matches the performance of passive global equity markets over the long run while exhibiting a superior risk-adjusted performance through a lower volatility and correlation profile than public equities. Examples of these strategies are long-biased long/short equity and credit hedge funds that pursue attractive absolute returns with mitigated risk.

Diversifying Strategies - The Diversifying Strategies portfolio aims to produce a return stream that (a) is not meaningfully correlated to either risk-on exposure (equity and credit) or risk-off exposure (duration) measured over long time horizons, and (b) exceeds 90-day T-bills + 3% over long time horizons. Examples of these strategies include macro, trend-following, relative value and market-neutral hedge funds. We expect to add certain non-hedge fund strategies as well.

Private Equity - The Fund seeks to partner with a small group of exceptional private equity managers who have strong track records, proven operating abilities, and histories of emphasizing downside protection. Most of our private equity managers seek to generate strong returns by acquiring private businesses and enhancing their value through growth and operational improvements. Our other private equity managers seek to invest in and help grow emerging companies.

Real Estate - The Fund has been pursuing real estate investments tactically, as we see reasons for caution throughout the marketplace. Recent investments have focused on sharpshooters with deep capabilities in a particular market or property type.

Natural Resources - The Natural Resources portfolio seeks to generate strong long-term returns with substantial exposure to commodity prices, especially energy. Management has focused on private funds that invest primarily in companies that own and operate energy-producing assets but also has a smaller amount of exposure to firms focusing on energy services. We continually review other strategies as well, including those focused on commodities other than energy.

Managing the Portfolio's Risks

Risk measurement, monitoring and management are critical aspects of investing. As previously mentioned, the challenging investment environment has led your Fund’s Management to adjust its investment strategies. In some cases, these changes entail greater portfolio complexity.

To keep pace, we have been enhancing our risk-related systems and processes. Our Director of Investment Risk is coordinating and upgrading our exposure analysis and other risk functions. Below are some of the many steps we take to measure, monitor and manage risk in the portfolio:

  • We perform quantitative modeling to understand a variety of portfolio risks and sensitivities to possible economic scenarios.

  • We manage the Fund’s liquidity, based on a combination of historical analyses and forward-looking projections, to ensure an uninterrupted stream of benefit payments.

  • We regularly monitor our exposures and concentrations by various categories to ensure appropriate diversification across a variety of metrics. We monitor certain key items daily, while others we track weekly or monthly, or, in the case of most private (illiquid) asset classes, quarterly.

Looking Forward

Fund Management remains focused on both setting a thoughtful asset allocation that balances the collection of risks we accept as well as carefully selecting and sizing a range of strategies and managers who we believe can achieve our investment objectives. This will enable us to provide our participants with sound benefits that help ensure economic security for participants dedicating a career of service to the YMCA. The Fund’s Management Team and Trustees remain committed to their mission and are confident that the Fund’s evolving portfolio positions the Fund to achieve its goals.​