Investor Presentation Fourth Quarter 2018 Market Review Bonds - - PowerPoint PPT Presentation

Investor Presentation

Fourth Quarter 2018

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• Across the board, it was an extremely difficult year to make money in the financial markets. U.S. and global stocks dropped

sharply in the fourth quarter, capping a year marked by turbulence and losses across most asset classes.

• U.S. stocks fell 13.6% for the quarter—it’s worst quarterly return in seven years. For the year, U.S. stocks were down a more

modest 4.5%. The negative year broke the S&P 500’s remarkable nine-year run of positive returns. Foreign stocks struggled as well, with developed international and emerging-market stocks both ending the year down just under 15%.

• Core bonds, which typically perform well when stocks do poorly, had losses through November. But a strong rally in Treasury

bonds in December resulted in a flat return for the year. More credit-sensitive sectors of the bond market—high-yield and floating-rate loans—were negative in the fourth quarter, but floating-rate loans managed to grind out a slightly positive return for the year.

Source: Morningstar Direct. Data as of 12/31/2018.

Market Review

1.6%

• 3.5%
• 4.7%
• 13.6%
• 20.3%
• 13.3%
• 6.4%
• 2.8%
• 2.8%
• 0.1%

0.4%

• 2.3%
• 4.5%
• 11.1%
• 14.8%
• 14.8%
• 2.1%
• 8.1%
• 24.0%
• 20.0%
• 16.0%
• 12.0%
• 8.0%
• 4.0%

0.0% 4.0% Invest-Grade (Interm-Trm) Floating-Rate Loans High-Yield U.S. Larger-Cap U.S. Smaller-Cap Developed International Emerging Markets Alternative Strategies Managed Futures

Bonds

Q4 2018 Year-to-Date

Stocks Alternatives

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2018 Was an Extremely Difficult Year for Financial Markets

Source: Morningstar Direct. Data as of 12/31/2018. 55% 3% 14% 0% 80% 6% 6% 11% 19% 30% 36% 52% 59% 1% 2% 4% 3% 10% 93% 5% 3% 58% 6% 34% 22% 67% 16% 5% 80% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Percentage of Morningstar Categories with Negative Returns

84 of 105 Morningstar categories were negative in 2018

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Volatility is Likely to Remain Elevated Over the Near Term

Source: Morningstar Direct. Data as of 12/31/2018.

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Global Economic Outlook

Macroeconomic uncertainty is elevated and there are a wide range of potential outcomes

• ver the near term.

Key macroeconomic questions to consider in 2019 and beyond:

• Will the trade war abate?
• How much will China stimulate their economy?
• Will uncertainty remain elevated across the eurozone?
• In the United States, will the Fed keep raising rates?
• How will the U.S. economy and global financial markets perform in a “late-cycle” environment?
• Is a global and/or U.S. recession on the horizon?
• How much of the macroeconomic uncertainty is already discounted in the financial markets?

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The U.S. Economy Remains Solid as the Current Cycle Extends

Source: National Bureau of Economic Research. Data as of 12/31/2018. 20 40 60 80 100 120 140 March 1991 June 2009 (Current Expansion) February 1961 November 1982 November 2001 Average Post-WWII Expansion March 1975 October 1949 May 1954 October 1945 November 1970 April 1958 July 1980

Duration of Expansion (Months)

Current U.S. Expansion Now Second Longest on Record

The current U.S. economic expansion will become the longest

• n record if it makes it to July 2019

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We are Late in the Market Cycle, But the Timing of the Turn is Always Uncertain

*National Bureau of Economic Research (NBER) defines an economic recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. Source: U.S. Federal Reserve. Data as of 12/31/2018. 0% 5% 10% 15% 20% 1965 1971 1977 1983 1989 1995 2001 2007 2013 2019

Fed Tightening and Recession Often Coincide

Federal Funds Rate Note: Shaded areas represent NBER- defined recessions*

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U.S. Stocks are Still Expensive Across a Number of Metrics

Source: Ned Davis Research. Data as of 12/31/2018.

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• Our base-case macroeconomic scenario calls for a continuation of the moderate economic recovery, both in the United States

and globally, and assumes earnings growth and interest rates “normalize” over our five-year investment time horizon. We don’t believe a recession is likely over the near term (six to 12 months), but as the Fed tightens monetary policy the odds

• increase. A trade war further increases the odds. We think a U.S. recession is highly likely within our five-year tactical horizon—

the business cycle has not been repealed.

• The base case also implies low expected returns for both U.S. stocks and U.S. core bonds. As such, our portfolios are tilted

toward opportunities we believe offer more attractive risk-adjusted return potential—specifically, non-U.S. stocks, non-core fixed-income strategies, and alternative strategies.

Investment Outlook

Asset Class Outlook and Positioning U.S. Stocks

U.S. stocks are overvalued and their medium-term return potential is unattractive. We maintain meaningful exposure to U.S. stocks, but remain underweight relative to our strategic, or neutral, allocation.

Developed International Stocks

Valuations for European stocks are attractive and potential excess returns over U.S. stocks are in the upper single digits

• ver the medium term. We have meaningful exposure to international stocks, with a slight overweight position in

Europe.

Emerging-Market Stocks

Corporate earnings growth is recovering, yet remains far below the peak reached before/during the financial crisis. Valuations for emerging-market stocks remain attractive relative to U.S. stocks. We maintain a slight overweight to emerging-market stocks.

Investment-Grade Bonds

Low current yields and the likelihood of rising interest rates imply low potential returns. We’re heavily underweight investment-grade bonds in favor of flexible core bond funds, unconstrained and absolute-return-oriented funds, and floating-rate loan funds we believe have the ability to generate higher returns and better manage their sensitivity to rising interest rates.

Alternative Strategies

We own a mix of alternative strategies we believe improve the overall risk-adjusted return potential of our portfolios, with mid-single-digit return potential for liquid strategies and different risk and return drivers than traditional stocks and bonds.

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Asset Class Return Estimates

Average Annual Returns Over Next Five Years

Equity Asset Classes

Bear Case BASE CASE Bull Case U.S. Larger Cap

• 6.1%

3.3% 11.6% Developed International - Europe

• 6.1%

16.6% 19.9% Emerging Markets 0.2% 11.3% 18.7%

Fixed-Income Asset Classes

Bear Case BASE CASE Bull Case Investment-Grade Bonds 4.5% 2.8% 2.1% High-Yield Bonds 2.7% 3.3% 3.1% Floating-Rate Loans 7.4% 6.1% 7.2%

Alternative Asset Classes

Bear Case BASE CASE Bull Case Alternative Strategies Mid-single-digit returns in most scenarios

S&P 500 at 2507, Barclays Aggregate yield at 3.3%, MSCI EM Index at 966, MSCI Europe Index at 1486, BofA ML High Yield Cash Pay Index at 7.1%.

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The near-term outlook for international and emerging-market stocks is clouded by a series of upcoming events and macroeconomic uncertainty:

• Global Economic Slowdown
• Federal Reserve Monetary Policy Tightening
• Global trade and tariffs
• Brexit Showdown
• Italian budget dispute
• U.S. Political Disfunction

Current Issues Impacting International and Emerging-Market Stocks

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Despite these near-term issues, there are reasons for optimism for long-term investors:

• Uncertainty and fears of an economic slowdown have been discounted by the

market—to a certain extent

• Potential for fiscal and monetary stimulus in China and fiscal stimulus in Europe, Latin

America, and Asia

• Valuations for European and emerging-market stocks are historically cheap relative to

the United States

• The outperformance of U.S. versus international stocks isn’t sustainable, especially

given current valuations

• Our active fixed-income and equity managers are finding attractive bottom-up

investment opportunities, especially after the recent sharp selloff

Reasons for Optimism

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European and Emerging-Market Stocks are Trading at a Significant Discount to U.S. Stocks

BCA Research. Data as of 12/31/2018.

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International Stocks Have Historically Performed Well When U.S. Stock Returns Are Low

Source: Morningstar Direct. Concept from Blackrock. Data as of 12/31/2018. Note: Int'l stocks is represented by MSCI World ex. U.S. from 1970 to 1988 and MSCI ACWI ex. U.S. from 1988 onward.

51% U.S Outperforms (241 of 469) 2% 49% Interntional Outperforms (228 of 469) 98% International Outperforms (65 of 66) 100% International Outperforms (45 of 45) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% All Returns U.S. Returns <6% U.S. Returns <4%

International stocks have historically performed well when U.S. stock returns are low

Rolling 10-Year Outperformance: U.S. Stocks vs. International Stocks

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Source: AQR and Morningstar Direct. Note: Managed Futures represented by AQR’s Trend-Following time series.

• 29.3%
• 42.6%
• 16.5%
• 29.6%
• 44.7%
• 50.9%

72.6% 108.0% 58.0%

• 3.9%

27.3% 29.3%

• 60%
• 40%
• 20%

0% 20% 40% 60% 80% 100% 120% Stagflation

• Dec. 1968 - Jun 1970

Oil Crisis

• Jan. 1973 - Sept. 1974

Recession

• Dec. 1980 - July 1982

Black Monday

• Sept. 1987 - Nov. 1987

Tech Bubble

• Sept. 2000 - Sept. 2002

Great Financial Crisis

• Nov. 2007 - Feb. 2009

Managed Futures Performance in Last Six Bear Markets

U.S. Stocks (cumulative return) Managed Futures (cumulative return)

Managed Futures Provide Valuable Risk Management Benefits When Investors Need Them Most

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Disclosure

Asset Class Descriptions:

Domestic Investment-Grade Bonds (Barclays Capital U.S. Aggregate Bond Index): We are currently using the Vanguard Total Bond Market Index Fund to represent the Barclays Capital U.S. Aggregate Bond Index, an index of domestic investment grade bonds. Floating Rate Loans (S&P/LSTA Leveraged Loan Index): We are currently using the S&P/LSTA Leveraged Loan Index to represent an index of floating rate loans. High Yield Bonds (Merrill Lynch U.S. High Yield Master Cash Pay Index): We are currently using the Merrill Lynch U.S. High Yield Master Cash Pay Index to represent an index of domestic high yield bonds. Domestic Larger-Cap Stocks (S&P 500 Index): We are currently using the Vanguard 500 Index Fund to represent the S&P 500, an index of primarily domestic larger-cap stocks. Domestic Smaller-Cap Stocks (Russell 2000 Index): We are currently using the Russell 2000 Index iShares Exchange Traded Fund (ETF) to represent the Russell 2000, an index of primarily domestic smaller-cap stocks. International Developed-Market Stocks (FTSE Developed ex North America Index): We are currently using the Vanguard FTSE Developed Markets Exchange Trade Fund (ETF) to represent an index of international developed-market stocks. Prior to May 2013, this Vanguard Exchange Traded Fund followed MSCI-EAFE. Prior to the July 2007 inception of Vanguard MSCI EAFE ETF, we use iShares MSCI EAFE Index from September 2001 to July 2007, and the MSCI EAFE Index adjusted for 0.35% expenses annually prior to September 2001. International Emerging-Market Stocks (FTSE Emerging Markets Index): We are currently using the Vanguard FTSE Emerging Markets Index Exchange Traded Fund (ETF) to represent an index of emerging market stocks. Prior to January 2013, this Vanguard Exchange Traded Fund followed the MSCI Emerging Markets Index. Prior to the March 2005 inception of Vanguard MSCI Emerging Markets ETF, we use iShares MSCI Emerging Markets Index from May 2003 to March 2005, and the MSCI Emerging Markets Index adjusted for 0.67% expenses annually prior to May 2003. Managed Futures: We are currently using an average of the AQR Managed Futures Strategy HV, Natixis ASG Managed Futures Strategy Y and PIMCO TRENDS Managed Futures Strategy. Arbitrage Strategies: We are currently using an average of the AQR Diversified Arbitrage Strategy (ADAIX) and the Arbitrage Event Driven Strategy (AEDNX). Advisory services offered through Alsworth Capital Management, LLC, an independent Registered Investment Advisory firm. Broker Dealer services offered through Cadaret, Grant & Co., Inc. Member FINRA/SIPC. Alsworth Capital Management, LLC and Cadaret, Grant & Co. are separate entities. Projections and opinions in this presentation are attributed solely to Shane Alsworth and Alsworth Capital Management, LLC.