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1st Quarter 2019 Market Update

30 October 2019

Geremy van Arkel, CFA® | Principal

Volatility and Risk…Not One and the Same

It is ubiquitous in the investment industry to use the word volatility to describe risk, and vice versa. But risk and volatility are not the same things. To Frontier, risk is the possibility of material or long-term loss of investors’ money, whereas volatility is the normal random price changes – both positive and negative – that occur along an investors path. Risk is like a powerful wave causing sweeping damage, while volatility is more like ripples of price change on the surface of the water. The concepts may be similar, but not the same thing when it comes to real investors’ money.

The last six months for capital markets price movements are a clear example of normal random volatility. In the 4th quarter of 2018, the S&P 500® Index – a broad measure of U.S. stock performance – lost 13.5%. This may be an eye-opening loss, yet it is no cause for fear: as if on cue, we entered 2019 with an S&P 500® gain of 13.7%. The result: we just returned to where we started. There is no need for risk management – if you believe the passive indexing theory, that is.

The reality is that a 13.5% decline followed by a 13.7% gain results in a loss of money. An Individual who invested $1 million in the S&P 500® Index on September 30 would have lost approximately $16,500 over these two quarters. Why a 13.5% decline followed by a 13.7% gain results in a loss is not a mystery. It is because of the basic investment concept of geometric compounding. Losses result in fewer dollars invested over time, requiring more and more positive return to make up the difference. This is exactly why risk management has a material advantage – even during periods of volatility when it appears no damage has been done. This, too, is the reason why Frontier’s core risk-managed strategies of Conservative, Balanced, and Growth & Income all fared well even during this bout of seemingly innocuous volatility. Also noteworthy is the fact that they did this with less loss, and pain associated with that loss, during the decline.

The first quarter was a mirror reversal of the declines of the 4th quarter, with almost all equity asset classes reversing their losses with about equal corresponding gains: U.S. stocks gained close to 14%, while international stocks and emerging markets stocks gained 10%. The surprise for the 1st quarter was the above yield returns for high-quality fixed-income assets. These assets are traditionally seen as being inversely related to equity asset prices and strong economic conditions. With equity prices producing double digits, high-quality fixed-income assets are expected to decline slightly in value. Yet as we have seen before, there seems to be a dichotomy of opinions between equity investors betting on economic growth, and fixed-income investors disbelief in future economic strength and willingness to sit this one out. But fixed-income investors may just have a case. While the economic growth assets of stocks did see strong price performance during the quarter, the actual economic growth indicators continued to point to weakness or at least a slowing during the quarter. Time will tell if higher asset prices can continue to keep this growth engine going, or if the 4th quarter declines really did foretell an inevitable economic slowdown.

While risk management, or outperforming in poor market environments, has its advantages almost all the time, the incredibly strong first quarter, too, proved to be a very good relative quarter for Frontier investors. The combination of managing Frontier strategies below benchmark risk exposures and the security selection prowess of the mutual funds that comprise our strategies not only produced a risk-mitigating performance in the 4th quarter but also enabled most Frontier strategies to outperform benchmarks during the first quarter’s blast-off recovery. This, as shown earlier, produces more dollars for investors through times of volatility – even during periods when steep declines are offset with equal gains, and when it seems like capital markets prices have not materially changed overall.

Additional Information
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 an investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. All performance results should be considered in light of the market and economic conditions that prevailed at the time those results were generated. Before investing, consider investment objectives, risks, fees and expenses.
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.
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance.  References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries or financial instruments of any kind.  This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment or tax advice.
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.
In reviewing the performance information presented here, 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. The performance information presented here covers different time periods. 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. For any investment products mentioned herein, a complete description of their investment objectives, along with details of the risks and fees involved is contained in their respective prospectus and statement of additional information, which is available on their websites and should be read fully.
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.
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
HFRX Absolute Return
The HFRX Absolute Return Index is designed to be representative of the overall composition of 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.
Barclays Capital Long U.S. Treasury
Includes all publicly issued, U.S. Treasury securities that have a remaining maturity of 10 or more years, are rated investment grade, and have $250 million or more of outstanding face value
Barclays US Aggregate Bond
Measures the performance of the U.S. investment grade bonds market. The securities must have at least one year remaining to maturity, must be denominated in U.S. dollars and must be fixed rate, nonconvertible and taxable.

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