How The Fund Works

Investments & Performance
Investment Review
For the Quarter Ended September 30, 2017

Overview

In recent years, we have discussed how the environment of low interest rates, low inflation, and low growth augured low investment returns. All along, we have acknowledged that the ongoing massive monetary easing could continue to propel the flow of capital to risk-oriented assets and hence prop up their prices, as it has in the years since the Great Financial Crisis.

We seem, however, to be at an inflection point in this multiyear pattern. The trend of interest rates, inflation, and growth may be changing due to (1) the recently announced and commenced changes in monetary policy by the central banks in the US and Europe; (2) the potential for long-term changes in US fiscal policy; (3) positive economic data around the globe; and (4) strong corporate earnings growth. This has reawakened animal spirits among some market participants and driven up the prices of risk assets, particularly equities.

Monetary policy seems to be changing globally from its dovish tone of the last few years toward a somewhat more hawkish one.

  • In September, the US Federal Reserve Bank announced that in October it would begin normalizing its balance sheet, although it has also hiked policy rates twice this year so far and is expected to hike a third time in December.

  • In Europe, the European Central Bank announced in late October that it would reduce its bond purchases in January 2018 from its current monthly pace of €60 billion to €30 billion, whereas the Bank of England is considering a rate hike in November.

  • Canada also had a surprising 25 basis points (bps) rate hike in September, its second of the year.

In the US, fiscal policy also seems to be on the verge of change, with the likelihood increasing for a tax bill in 2018, as the Senate passed its 2018 fiscal year budget resolution in mid-October. This allows the Senate to pass a tax bill with a simple 51-vote majority.

Inflation continues to remain stubbornly low globally, although it has been picking up recently. Year-over-year CPI for the world in aggregate was 2.2% in August. Within the US, CPI was 1.9%, was 1.7% in the European Union, was 0.7% in Japan, and averaged 2.9% in the emerging market economies.

Similar to inflation, wage growth remains tepid, although it also seems to be on an upward trend. The US unemployment rate in September fell to 4.2% from 4.7% at the end of 2016, while wage growth increased from 0.8% to 3.2% over the same period.

Corporate earnings growth has been strong this year and has increased significantly year over year. In Q2 2017, year-over-year earnings for the S&P 500, Stoxx 600, and Nikkei 225 grew by 9.7%, 34.9%, and 36.9%, respectively.

Even with the generally positive economic outlook, when factoring in the now-higher equity prices, 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.

Against this backdrop, the Fund enjoyed a strong quarter, growing 3.2%. In addition, the Fund registered investment returns of 10.8% for the first nine months of 2017. As a long-term investor, we pay more attention to longer periods; over five- and seven-year periods, for instance, the Fund generated annualized returns of 7.8% and 8.0%, respectively, net of fees. These five- and seven-year figures are encouraging, as they exceed the threshold required to match the growth of our liabilities. However, we recognize that these periods do not include a period of significant market downturn. The 10-year returns of 4.4% reflect and capture the horrible bear market of 2007–2009.

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 the 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 a different and not highly correlated fashion under different economic conditions

  • 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 investing in private investments in several asset classes in exchange for higher expected returns

  • 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

Macroeconomic and Market Environment

In the third quarter, US equity markets continued to rally on the back of strong earnings growth, good economic data, and the potential of tax reform. This marked the eighth consecutive quarter of positive performance for the S&P 500, but this quarter has been accompanied by historically low market volatility. Throughout the quarter, the S&P 500’s average daily change was a mere 0.3%, its lowest level since 1968. Overall, the US economy appears strong as favorable economic results continue to come out and leading economic indicators remain positive. Unemployment in June reached its lowest levels in 16 years, and the September figures for the US PMI and NMI indicate a robust economy.

This pattern has continued thus far in October. Reports on US GDP indicate growth at a real rate greater than 3% for the last two quarters, and US stock markets have continued their advance, while volatility remains muted.

European markets also rallied in the third quarter on the back of continued earnings growth, Merkel’s election victory in Germany, and the continued accommodative monetary policy of the European Central Bank. However, the UK seems to be doing worse than the European continent, as inflation continues to be high, with input prices rising 7.6% year over year in August and producer output prices and consumer prices rising 3.4% and 2.9%, respectively. The OECD also released its revised estimates of growth and ranked the UK as the G7 economy with the slowest growth this year, likely due primarily to the impact of the Brexit vote.

The aggregation of twenty-three countries’ markets, known collectively as emerging market (EM) equities, has been the standout this quarter, performing far ahead of US and European equities. The MSCI EM index returned 8%, while the S&P 500 returned 4.4% and the Eurostoxx 600 returned 6.2%. Calendar year-to-date returns have been particularly strong, as the MSCI EM index returned 28.1% through September. The EM equity performance has been supported by earnings strength, US dollar weakness, and improving global trade. However, the index’s performance was not evenly distributed. Performance was heavily influenced by the IT sector, which accounted for 47% of the MSCI EM index’s gains in the third quarter, with particularly strong performance coming from Chinese IT stocks.

On a global level, there is a generally positive sentiment regarding the macroeconomic environment, which has supported global risk assets in the third quarter. According to data from the IMF, 2017 is expected to be the first year in a decade in which the economies of all the countries in the MSCI World and MSCI EM index are in synchronized expansion. Monetary policy is expected to remain relatively accommodative globally, which should support asset prices, while global inflation remains subdued. However, there are potential risks and uncertainties that loom ahead. In the European Union, there remains the risk of a hard Brexit, the possible impacts associated with the Catalan separatist movement, and the potential for rate hikes as the ECB begins the tapering of bond purchases in January 2018. Lastly, in the US, there is the uncertainty around the next Fed chief and the policy reform, along with the potential for further rate hikes if the Fed finds itself behind the inflation curve.

September Quarter Portfolio Performance

Your Fund had a positive quarter and a strong calendar year-to-date in absolute terms, respectively returning 3.2% and 10.8% net of fees (neither number is an annualized figure). We focus primarily on absolute returns, since these are ultimately what is required to meet our investment objectives and the Fund’s obligations. However, relative returns (versus a benchmark of similar investments) can be a helpful data point as well. During the quarter, the Fund lagged behind the Composite Benchmark by 34 bps. However, over longer periods of five and seven years, we have generally outperformed this benchmark by +13 bps and +25 bps, respectively.

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 $6.5+ 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-five years, broad and index-like exposure to stocks and bonds has been sufficient to fulfill the Fund's mission. We do not believe that this 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.

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