How The Fund Works

Investments & Performance
Investment Review
For the Quarter Ended March 31, 2017

Overview

In recent years, we have discussed how the environment of low interest rates, low inflation, and low growth augured low investment returns, and have suggested that little on the horizon seemed likely to change things. That changed in November, as the outcome of the U.S. presidential election rocked the outlook for interest rates, inflation, and growth, with credible reasons for thinking each could rise.

As often happens, equity markets have raced ahead since that initial positive news, seemingly continuing to price in many events that have yet to materialize. Consumer confidence has surged to heights not seen since the global financial crisis, and business investment has moved up worldwide on such optimism. Nonetheless, it actually remains to be seen how much this will change things in Washington. Tax reform, health-care legislation, government spending, and bank deregulation haven’t yet taken the promised shape, notwithstanding some pertinent executive orders. Of course, some time is probably required for the enactment of such consequential and complicated change, so these measures haven’t necessarily stalled. It simply remains to be seen how much the U.S. economy might change.

Even with the potential for an improved 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 returns approximating the rate at which their liabilities grow. In light of this, the Fund continues 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 4.3%. In addition, it is up 10.3% for the first nine months of Fiscal Year 2017. As a long-term investor, we pay more attention to longer periods; over three-, five-, and seven-year periods, for instance, the Fund generated annualized returns of 4.6%, 7.1%, and 7.5%, respectively, net of fees. These five- and seven-year numbers are encouraging, as they meet the threshold required to match the growth of our liabilities but do not include a period of significant market downturn.

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:

  • 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 horizon 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. This diversifies the Fund’s sources of return and positions the Fund to fall less than stocks when equity markets decline

MACROECONOMIC AND MARKET ENVIRONMENT—The United States

As mentioned, U.S. equity markets continued rallying strongly in the first quarter on continued momentum from the presidential election, due to the promises of deregulation, slashed corporate and personal tax rates, and increased government spending. Many economic indicators have supported and propelled this rally: jobless claims have reached levels not seen for decades, purchasing manager indices (PMIs) show businesses buying inventory in hopes of demand, and corporate profits are continuing a rebound from the lull of the last couple of years. Nonetheless, some of this data is “soft,” as it consists of things like surveys on confidence. As such, they don’t as directly indicate broad-based improvement in economic activity as an outright GDP rise might. Moreover, some of the other indicators (e.g., jobless claims) may simply be continuing trends that were already in place before the election.

In fact, U.S. and global economic conditions began to improve in mid-2016. The key drivers of this were (a) actions by central banks (the Fed paused rate hikes, while the European Central Bank and Bank of Japan each announced record monetary easing), (b) fiscal stimulus in China via a huge liquidity injection, and (c) the rebound in oil prices and greater shale activity. Each of these three economic drivers has reversed in recent months.

Most financial markets have begun correcting or reversing trends to reflect this. The lone exception has been equity markets, which remain at or near record highs. Management is mindful that resolution of this discrepancy between different financial markets could significantly influence market prices and portfolio asset values.

A similar situation unfolded in Europe over the quarter, as European equities were also meaningfully up. PMIs were up in Europe as they were in the United States, and there were strong releases on corporate earnings growth. The Dutch and French election outcomes provided relief to markets. Moreover, while Theresa May’s government has taken steps to structure the Brexit negotiations, the details of that arrangement remain to be worked out. Longer-term problems also remain, as European banks still struggle with bad balance sheets, as immigration continues to be a concern, and as negative population growth and low productivity growth weigh on economic prospects.

The aggregation of twenty-three countries’ markets known collectively as emerging markets (EM) had the greatest absolute return of equity markets in the quarter, with the MSCI EM Index returning 11.5%. This was driven by two of the largest markets, as there was a return of positive economic data in China and another victory in India for Modi’s pro-business, pro-reform political party. The success of the developed world also helped, as there were large monetary flows into EM, and as developed world growth should fuel future demand for EM producers.

In April, the United States and China appeared to have a productive conversation around trade status, but this remains a very live issue, as do the conversations with Mexico and Canada surrounding NAFTA. Furthermore, tension with China and Russia stems from concerns over the superpowers’ handling of North Korea and Syria, not to mention the ongoing debate around Russia’s alleged involvement in the US presidential election. North Korea and Syria could each become even bigger concerns in their own right, while exacerbating the continuing global debate over nuclear proliferation and immigration, respectively.

MARCH QUARTER PORTFOLIO PERFORMANCE

Your Fund had a strong quarter and a strong nine months in absolute terms, respectively returning 4.3% and 10.3% net of fees (neither number is an annualized figure). We focus primarily on absolute returns, since these are ultimately what is required to meet the Fund’s objectives and obligations. However, relative returns (versus a benchmark of similar investments) can be a helpful data point as well. During the quarter, for instance, the Fund outpaced the Composite Benchmark by +16 bps. Over longer periods of three, five, and seven years, we have generally outperformed this benchmark, with differentials of +9 bps, +44 bps, and +41 bps, respectively.

MARCH QUARTER—BY ASSET CLASS

The Fund's Public Equities as a whole gained 7.4% during the quarter. Our International Developed Markets managers continued to perform quite well, returning an absolute 7.8% for the quarter, versus the 7.0% of the benchmark. This relative outperformance was partly due to currency hedging, partly due to intentional regional tilts within developed markets, and partly due to the managers’ stock picking within those regions. Meanwhile, the United States and Emerging Markets were a source of strong absolute performance and flat relative performance. Both matched their benchmarks while respectively returning 5.6% and 11.6% in absolute terms.

The Rates portfolio, the mainstay of the Fund’s defensive allocation, appreciated by 0.6%. This portfolio comprises fixed-rate U.S. Treasury securities, which aim to reduce the Fund's risk and volatility, so this modest return was unsurprising.

Directional Hedge Fund Strategies slightly outperformed, partly due to the resurgence of health-care and tech stocks, as some of these managers have a bias toward these growth-oriented sectors. Diversifying Strategies underperformed, though the purpose of these managers is to reduce and diversify market exposure, and this long-term thesis remains intact.

The public equities in our Natural Resources portfolio suffered due to the dip in oil prices, but our energy credits had a positive return. The Credit portfolio in general did well, as the markets marked up high yield and stressed credit on the positive economic signals.

PORTFOLIO DEVELOPMENTS

Like most investors, the Fund's key risk factor is a sustained decline in global equity markets. Management has been taking the following steps, among others, as part of its ongoing effort to reduce—although certainly not eliminate—the Fund's exposure to equity market declines:

  • Maintaining exposure to U.S. government securities in our Rates portfolio

  • Increasing our allocation to certain diversifying strategies (some, but not all, of which are in hedge fund structures) whose portfolios are designed to generate acceptable and/or attractive returns over a cycle and generally perform differently from equity markets

  • Continuing allocations to assets with differentiated risk factors, such as real estate and natural resources

  • Allocating to various opportunistic strategies, including private direct lending, that should provide attractive returns in most environments, but with some degree of downside protection

The Fund has also continued its pursuit of return via recent investments in several private equity managers and in public managers focused on health care and financials. These sectors have been interesting due to, among other reasons, selloffs in 2016 and positive growth prospects, 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+ billion of pension assets with which we are entrusted.

Many institutions 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 above.

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 this is so today. Therefore, 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 having 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.