How The Fund Works

Investments & Performance
Investment Review
For the Quarter Ended September 30, 2018
Overview
 

What Bull Market? Through the third quarter of 2018, most asset classes in most geographies displayed lackluster performance. As shown in the adjacent table, fixed-income markets of all types – foreign currencies, international stock markets, commodities – were all down or up quite modestly year-to-date. The lone exceptions (see bottom of table) – lucky us (lucky US!): US stocks and the US dollar (USD). Each of these remains in a bull market that some would describe as ten years old.

  2018 YTD Returns
Through September 30 
   ≤ 0%  0-5%  ≥ 5%

Fixed Income

 

 

 

3 Month US Treasuries

 

+1%

 

Intermediate US Treasuries

(1%)

 

 

Barclays Global Agg.

(2%)

 

 

HY Bonds

 

+2%

 

EM Bonds

(3%)

 

 

Commodities

 

 

 

Bloomberg Commodities Index

 (3%)

 

 

Gold

 (9%)

 

 

International Equities (in USD)

 

 

 

Europe

 (2%)

 

 

Japan

 

+2%

 

China

 (9%)

 

 

Emerging Markets

 (7%)

 

 

Currencies (vs USD)

 

 

 

Euro

(3%)

 

 

British Pound

(4%)

 

 

Japanese Yen

 

+1%

 

 Chinese Yuan

 (5%)

 

 

 U.S. Dollar (USD)

 

 +3%

 

 U.S. Equities

 

 

 

 S&P 500

 

 

 +11%

 Russell 2000

 

 

 +12%

 

Periods like this tend not to last. Usually it’s the exceptions that join the majority, not vice-versa. So, we may see US markets languish going forward and join the pack. Reasons for this abound, but market participants have not placed great attention on these (yet?). These include:

  1. Interest rates rising

  2. Nationalism leading to civil unrest, reduced trade, and possibly even military engagement

  3. Trade wars intensifying, leading to reduced trade, higher costs and prices, and production delays

  4. Geopolitics threatening to upend the status quo on nearly every continent

Economic Environment. One year ago, we were in an environment of synchronized global growth, and now we seem to be transitioning into one of divergence, with the US economy outperforming, growing recently at a real rate greater than 3% (and just over 5% nominally). Meanwhile, many other countries have entered a moderate slowdown. This dynamic has been reflected in equity markets. US equities have continued their ascent, achieving record highs, while the rest of the world’s equity markets have lagged behind, particularly those of the emerging markets. We will have to see the delayed impact that the late 2017 tax cuts have on longer-term total demand after it has its positive impact in 2018 and, likely, 2019.

If this future tighter fiscal policy ends up being paired with tighter monetary policy and diminished liquidity by central banks (albeit from record high levels), we could have the basis for a meaningful economic slowdown – and perhaps even a recession.

Markets. Strong US performance has resulted from continued strong earnings growth (partly the result of the 2017 US tax reform), record low unemployment, and strong consumer confidence. During this time, the Fed hiked rates (for the third time this year and eighth time this cycle), lifting the federal funds rate to 2.25% and the prime rate (the rate the banks charge their best customers to borrow) to 5.25%. These rate hikes have caused the USD to appreciate and has put pressure on all countries and currencies. The pressure has been particularly acute on emerging market countries, especially those with considerable dollar-denominated debt. This, along with slowing growth relative to the US abroad, particularly in China, has led to the differential in performance.

Despite the differentials in equity market performance, global growth remains robust, while inflation has remained tame. Monetary policy outside of the US remains accommodative, and it seems the risk of a recession in the near term remains low, although the longer-term outlook remains more uncertain.

The Fund’s Returns. Against this backdrop, the Fund enjoyed a positive quarter, growing 3.0% (shown net-net, after all management fees paid and the Fund’s investment-related costs, as are all return figures herein shown). As a long-term investor, we pay more attention to longer periods. Over the last five, seven, and ten years, for instance, the Fund generated annualized returns of 7.0%, 9.0%, and 7.2%, respectively.

These results are encouraging, as they exceed the threshold required to match the growth of our liabilities. We recognize, however, that these periods do not include a full period of significant market downturn.

While we primarily focus on absolute returns, relative returns (versus a benchmark of similar investments) can be a helpful data point as well. During the quarter, our Fund outperformed our customized Composite Benchmark by +53 bps. Over longer periods of five, seven, and ten years, we have outperformed this benchmark by +23 bps, +65 bps, and +21 bps, respectively.

When one factors in higher discount rates on future earnings and cash flows, it still appears to be difficult for many retirement plans (such as ours) to find attractive generic opportunities to earn long-term returns approximating the rate at which their liabilities grow. In light of this, we at the Fund are continuing to work to structure a distinctive portfolio that we believe gives us the best chance of meeting our investment objectives.

SOME PERSPECTIVE: OUR GOALS AND CORE STRATEGY

The Fund's mission is to empower YMCA employees to achieve economic security, resulting in loyalty to the YMCA Movement. To help achieve this mission, the Fund seeks to build a portfolio that generates attractive long-term returns (over many years, cycles, and even decades) while maintaining defensive characteristics to safeguard our pension promises.
The core elements of our investment philosophy for achieving our mission include the following:

  • Building a diversified portfolio in which the several asset classes behave in different and not highly correlated fashions under different economic conditions.

  • Seeking to complement our predominantly equity market–influenced sources of return with other return drivers, thereby diversifying the Fund’s sources of return and positioning the Fund to fall less than stocks when equity markets decline.

  • Allocating capital to exceptional investment managers who we believe can produce superior returns through full market cycles.

  • Capitalizing on the Fund’s long-term horizons to accept some illiquidity by making private investments in several asset classes in exchange for higher expected returns.

MACROECONOMIC AND MARKET ENVIRONMENT

Global GDP growth for 2018 remains at 2017’s healthy pace of 3.7%, but it is not as evenly distributed. Growth in the US has continued to accelerate, largely due to fiscal policy, while it has moderated elsewhere, particularly in China. This slowdown in China has also affected many other emerging economies, especially commodity exporters. In addition to this pressure, the strengthening USD (abetted by the Fed’s continued rate hikes) has put pressure on countries that have large amounts of dollar-denominated debt, such as Argentina and Turkey.

United States

The US continued its strong performance in the third quarter, with the S&P 500 rallying 7.7% and positive performance coming from every sector. Earnings growth remains strong, with second-quarter earnings growing 25% from the previous year. Economic indicators for the US also remain broadly positive. CPI inflation has picked up from its 2017 lows but remains tame at 2.3% as of September. The unemployment rate has continued to grind lower and reached 3.7% in September, the lowest rate since 1969. Wage growth continues to increase, and the number of job openings has reached an all-time high at 7.1 million as of August, exceeding the number of unemployed Americans.

Although the outlook for the US is largely positive, there are several developments that are concerning. As a result of the good economic data, not only has the Fed continued raising policy rates, but its released Fed dots median suggests one further hike in 2018 and three additional hikes in 2019. As rates rise, so does the US government’s borrowing cost. This, coupled with our rising budget deficit, further swollen by last year’s tax cut and fiscal reform, means more money going to interest payments and less to infrastructure and other government programs. Another worrying development on the policy front: Escalating trade tensions between the US and China as President Trump levied an additional $200bn on Chinese imports in September.

Europe

European equities continued their advance in the third quarter but meaningfully underperformed US equity markets due to lower growth and heightened political uncertainty, especially in the UK. In the third quarter, UK equities detracted, which was the primary driver of European equities’ underperformance. The causes of this seem to be the possibility of a no-deal Brexit increasing as we come closer to the March 2019 deadline as well as a rate hike by the Bank of England, only the second in over a decade. Continental Europe fared better in the quarter, with equity markets notching gains, although concerns remain over Italy’s high debt load. The European Central Bank (ECB) has maintained its accommodative stance and signaled that it plans to keep interest rates low into next year but has confirmed a wind-down of its Asset Purchase Program by the end of the year.

Emerging Markets

Continuing the trend of the second quarter of 2018, the aggregation of twenty-three countries’ markets, known collectively as emerging market (EM) equities, sustained negative performance and entered technical bear market territory (when a market experiences a 20% decline in price). China drove the negative performance for the quarter, as its growth has begun to slow and trade tensions with the US continue to escalate. In response to the sell-off in Chinese equities, China has loosened both monetary and fiscal policies by cutting banks’ reserve requirement ratios and introducing new tax breaks for financial institutions to encourage lending. Other EM countries also faced the headwinds of a stronger USD and continued external deficit funding concerns.

OUTLOOK

As has been the case for a few years now, Management views few asset classes and investment strategies as attractively priced for buyers. This makes for challenging times as we seek to protect and grow the $7 billion of pension assets with which we are entrusted.

Many institutions that we respect share this view, including Cambridge Associates, our investment consultant, which evaluates most asset classes as being either overvalued or fairly valued. The result: few compelling options for investors and hence the potential for – and even likelihood of – lackluster returns going forward, as discussed previously.

During the Fund's ninety-six years, broad and index-like exposure to stocks and bonds has been sufficient to fulfill the Fund's mission. We do not believe that it will remain so over the next decade. As a result, Management is working diligently to add exposure to other sources of returns while also enhancing the Fund's ability to perform relatively well if market conditions deteriorate. We remain focused on maintaining and refining a well-diversified portfolio that is built for the long term and that tilts, when appropriate, to sectors of more attractive risk-adjusted returns.