2014: A year of simplicity

January 23, 2015

David A. Klassen, Chief Investment Strategist

Equity and fixed-income markets ended the year with mixed, but still positive results. Global economic and geopolitical concerns resurfaced, and there was more underlying turbulence than indicated by headline results. One business magazine called 2014 the year that nothing worked! A better way to say it might be: the best way to thrive was just to stay simple.

The first way to be “simple” was to invest in U.S. large companies, as represented by the Standard & Poor’s (S&P) 500 stock index, which returned 13.69% for all of 2014. Smaller companies returned less, only 4.89% for the year. Emerging market equities (MSCI EM) gave up positive early year outperformance and were down a disappointing 2.19% for 2014. Most complex was the return of the international developed equity markets index (EAFE), down 4.90%. Why complex? Although local stock market results were generally positive, U.S investors experienced negative returns due to the impact of translating returns in weaker currencies (euro, yen) back into the strong U.S. dollar.

The same simplicity dynamic held true in the fixed-income world, where U.S. treasuries and high quality corporates led the way as yields fell, and prices rose the most. This confounded the majority of experts expecting higher interest rates. Fixed-income benefitted from still-weak global economic growth, the spillover effect from a dramatic decline in bond yields in Europe, and very low inflation, made more pronounced by a sharp drop in energy and commodity prices.

The UCF Equity and Balanced Funds have meaningful equity allocations to the US, and the managers we hire on your behalf had an excellent year versus benchmarks. However, we are diversified globally, as the attractiveness of relatively strong growth in the US is still offset by somewhat less attractive valuations here and higher potential opportunities elsewhere in the world. Bottom line, though, being diversified, if even for good reasons, hurt this year.

As for the Fixed-Income Fund, which is also part of UCF Balanced Funds, our core fixed-income manager had been positioning our U.S.-oriented fixed-income portfolios to protect against an eventual rise in interest rates, with clear rationale. Although this manager had positive returns, they fared less well than prior years in generating benchmark-beating returns. A prudent diversification strategy into the two areas of bank loans and emerging market debt also held back performance.

Finally, where we are able to use diversifying strategies other than equities and fixed income, in the Alternatives Balanced Fund (such as real estate and absolute return strategies), we were successful in adding positive value above expectations and benchmarks.

For 2015, investors are likely to have concerns about the global economy. Slow but steady economic improvement, however, continues in the U.S. The conundrum in Europe remains whether more accommodative policy will offset the lack of growth and potential deflation. Some emerging economies have adjusted to fast-changing global growth patterns and investor sentiment, meaning selectivity remains vital internationally. Divergences in global growth have caused the US dollar to remain strong compared to most other currencies and this could continue, further complicating matters.

Over the long term, our priorities remain to scrutinize and select relationships with talented managers who are experienced at navigating these markets, to allocate assets to attractive asset classes, and to maintain high focus on the socially responsive mission of the United Church Funds.

 
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