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1st Quarter 2018 Market Update

07 April 2018

By Geremy van Arkel, CFA®
Principal

A return to volatility has become an overused but appropriate description of the first quarter. Following nine straight quarters of gains for the S&P 500® Index, and the longest streak on record without a 5% decline, the S&P 500® ended the quarter with a shallow loss of 0.8%. The widely accepted prediction was for the quarter to continue the trend of methodical marching towards even higher asset prices. An indication of the abundant overall optimism was evident in January’s Investors Intelligence Survey, which showed that just 12% of investment advisors were bearish, the lowest reading since 1996. Yet all of this optimism came to an abrupt full stop in early February when the Dow Jones Industrial Average dropped 12%, or 3,200 points in just two weeks.

Sometimes, when things seem like they can’t be any better, they don’t get any better.  The beginning of this year looked like a perfect scenario for investing safely in risky assets: the economy was strong, unemployment was near all-time lows, interest rates were low, a major corporate (and personal) tax cut had just been enacted, and business optimism was high.  When asset prices are high, and the economic backdrop can’t get any better, it only takes a dent to expectations to cause some serious volatility.

That “dent” was President Trump’s announcement that the U.S. was set to impose tariffs on steel and aluminum. When the market hears “tariffs”, it is thinking “trade war.” That, on top of fears of rising inflation and interest rates, and stock prices that cannot easily be described as inexpensive, sent stocks reeling. Perhaps the market belatedly discovered that tax cuts that might boost an already fairly strong economy can naturally lead to some inflation and a general increase in interest rates. Furthermore, federal government policies of deficit spending and tariffs are often inflationary, which further stirred the pot. Investors have long feared a return to inflation and the impact of rising interest rates leading to losses for bond investors. This outcome, which was only a matter of time, was taken in stride and bonds did produce small losses during the quarter. If only it were that simple.

Interest rates are also a vital component to the growth plan, for the prospects of the economy and, in turn, for stock prices. In short, much of the economic growth of the last decade can be attributed to low interest rates and a lot of borrowing. If interest rates rise enough, then the tailwind turns into a headwind. Higher inflation leading to higher interest rates slows future prospects for growth. While investors have long made vocal their hatred of bonds, it seems that this quarter they finally put two and two together. Once again, it was stocks that proved out to be the risky asset.

While this quarter was a radical departure from the smooth sailing that we have experienced over the past few years, it was not a particularly damaging one for long-term investors. January was an excellent month for investors, followed by tumultuous and unnerving storms and recoveries through February and March. Overall, indexes for U.S. stocks, international stocks, real estate, and bonds produced losses for the quarter. Yet, all Frontier strategies managed to achieve returns that were slightly above or below the zero line, and they did so while experiencing reduced inter-quarter volatility. Again, we achieved these risk-averse results not by perfectly predicting every twist and turn, peak and valley of the volatile capital markets, but through conservative positioning and through the added return of our mutual fund selection process. Specifically, our positioning to growth-oriented mutual funds, small cap mutual funds, and our unique bond positioning added return over indexes while dampening volatility.  Our battle-proven ship weathered this storm admirably.

Going forward, all Frontier strategies remain conservatively positioned in terms of asset allocation and mutual fund selection. More to that point, several of our strategies further reduced risk during the quarter by continuing to lower equity exposure. We remain concerned that the current high asset prices will likely lead to lower future expected returns for most asset classes. We also know how volatility can surprise investors during such times, like we just experienced.

1Q18 Quarter Strategy Review

The performance of Frontier’s Globally Diversified strategies during the down-month of March really showed off Frontier’s Downside First Focus philosophy and pushed 2018’s first quarter performance solidly into the better than average column, at least on a relative to benchmark basis. During March, all of the strategies posted positive before-fee returns, while all of the benchmarks had negative returns. For some perspective, both the S&P 500® Index and the MSCI World Index lost over 2% in the month. Just like in February, equities, commodities, and hedge fund strategies were down in March, but unlike February, fixed income provided some needed ballast. Most importantly long-term Treasuries recovered from their disappointing February and returned over 3% in March. The asset allocation mixes were therefore a big help in the month. But it was the fund managers’ performance and how we put them together that pushed March into the plus column. All mutual fund strategies except Global Opportunities would have been down in March if implemented with index funds.

March’s performance led all of the Globally Diversified strategies to better than benchmark returns for the quarter, and even though all of the benchmarks had negative returns, Growth & Income, Long-Term Growth, and Global Opportunities were all up for the quarter. The more conservative strategies were down a little in the quarter, but down less than their benchmarks. Across strategies the added value from the funds was the performance enhancer. Overall, the asset allocation mixes were a net neutral to performance in the quarter. Longer-term performance looks favorable relative to benchmarks for all strategies over nearly all historic time periods.

Frontier Asset Management’s unconstrained Alternative Strategies also did well in March with positive returns across the board; hedge funds which are similar in nature, according to the HFRX Global index, were down in March. All three strategies were helped by the rebound in fixed income prices and added-value from the funds in the strategies. For the quarter, all three strategies were down slightly, but fell less than the HFRX Global Hedge Fund Index. Like the globally diversified strategies, the added value from the funds and how we put them together kept the quarterly losses smaller than from hedge funds. Longer-term performance for these strategies continues to look favorable relative to the hedge fund universe and alternative strategies available in mutual fund formats.

– Gary A. Miller, CFA®

FRONTIER COMMENTARY:
Past performance is no guarantee of future returns. Performance discussed represents total returns that include income, realized and unrealized gains and losses. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any types of securities and no investment decision should be made based solely on information provided herein. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. Before investing, consider investment objectives, risks, fees and expenses.
In reviewing any performance information presented, we recommend that you consider both the returns generated and the level of risk that was assumed in generating those results. We believe that performance information cannot be properly assessed without understanding the amount of risk that was taken in delivering that performance. We present performance information for short time periods because we understand that clients and potential Investors are interested in this information, however, we recommend against making any investment decisions based on short-term performance information. Performance should be considered in light of the market and economic conditions that prevailed at the time those results were generated.
Information provided herein reflects Frontier’s views as of the date of this newsletter and can change at any time without notice. Frontier obtained some of the information provided herein from third party sources believed to be reliable but it is not guaranteed and Frontier does not warrant or guarantee the accuracy or completeness of such information.
Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision.
It is generally not possible to invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only available through third party investable instruments (if any) based on that index.
Index
Index Description
S&P 500
Represents US large company stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, AMEX, and NASDAQ
MSCI World
A free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index consists of the following 24 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States
HFRX Global
Represents the hedge fund universe. It is comprised of all eligible hedge fund strategies; including but not limited to convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. The index is weighted based on the distribution of assets in the global hedge fund industry. It is a trade-able index of actual hedge funds.
Benchmark Composition. The Benchmarks for the Long-Term Growth, Growth & Income, Balanced, Conservative and Capital Preservation strategies are combinations of the Wilshire 5000 Total Market Index, MSCI All Country World ex US Index, Bloomberg Commodity Index, HFRX Global HF Index, Barclays US Aggregate Bond Index and 3-Month T-Bills.
The blends of the indices are currently:
Capital Preservation Bench
Conservative Bench
Balanced Bench
Growth & Income Bench
Long-Term Growth Bench
Wilshire 5000
10%
15%
30%
45%
50%
MSCI AC World ex US
0%
5%
15%
20%
30%
Bloomberg Commodity
15%
15%
10%
10%
10%
HFRX Global HF
25%
25%
20%
15%
10%
Barclays US Agg
40%
40%
25%
10%
0%
3M T-Bills
10%
0%
0%
0%
0%
Benchmarks for the Global Opportunities, Focused Opportunities, Absolute Return Plus, Absolute Return and Short Term Reserve strategies are the MSCI World, S&P 500, HFRX Global HF, HFRX Absolute Return and Barclays Capital 1-5 Year US Treasury Indices, respectively. In the case of indices that include foreign securities, index returns are still presented on a total return basis, but will be net of foreign taxes on income generated by these securities.
 041718CST073118