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  Market Insights: Performance in Perspective—Headwinds for Multi-Asset Investors in 2016

With U.S. equities soaring to new highs and outpacing virtually every other asset class in 2016, many investors will find themselves looking at the statements of their investment accounts and asking, “Where is my fair share?” As practitioners in the investment advisory community, we all know and understand the long-term benefits of diversification, and we recognize the challenges in chasing performance. Recognizing that well-known and highly followed media outlets simply focus on the stock market and do not provide enough perspective into the performance of the global investment landscape, we would like to take the opportunity to provide our clients with a broad overview of the most important themes that impacted the performance of multi-asset portfolios in 2016, which we discuss below.

1) Underperformance of Active Managers—Most Indexes Outperformed the Average Manager in 2016

The first major headwind facing multi-asset portfolios in 2016 was the significant underperformance of active management relative to most major market indexes. The exhibit below provides a snapshot of how most major market indexes performed and ranked (on a percentile basis) relative to their respective Morningstar® catergories.

Exhibit 1: 2016 Calendar Year Index Performance Relative to Morningstar Category Averages

Index Morningstar Category Calendar Year 2016 Index % Return Index Percentile Rank Morningstar Category Average Return
BBgBarc US Agg Bond TR USD U.S. Fund Intermediate-Term Bond 2.65 63 3.23
BBgBarc Municipal TR USD U.S. Fund Muni National Interm. 0.25 24 -0.20
BofAML US HY Master II TR USD U.S. Fund High Yield Bond 17.49 6 13.30
S&P/LSTA Leveraged Loan TR U.S. Fund Bank Loan 10.16 30 9.25
S&P 500 TR USD U.S. Fund Large Blend 11.96 28 10.37
Russell 1000 TR USD U.S. Fund Large Blend 12.05 27 10.37
Wilshire 5000 Total Mkt TR USD U.S. Fund Large Blend 13.37 15 10.37
Russell 1000 Growth TR USD U.S. Fund Large Growth 7.08 23 3.23
Russell 1000 Value TR USD U.S. Fund Large Value 17.34 26 14.81
Russell 2000 Growth TR USD U.S. Fund Small Growth 11.32 50 11.20
Russell 2000 Value TR USD U.S. Fund Small Value 31.74 13 25.99
MSCI EAFE Value NR USD U.S. Fund Foreign Large Value 5.02 24 3.34
MSCI EAFE Growth NR USD U.S. Fund Foreign Large Growth -3.04 58 -2.14
MSCI EM NR USD U.S. Fund Diversified Emerging Mkts 11.19 34 8.47

Source: Morningstar

We can observe that approximately 70% (10 of 14) of the indexes shown above ranked in the top 30% of their respective universe, which implies that the indexes outperformed 70% of active managers. The results are even more staggering in asset classes such as High Yield Bonds (96% of managers underperformed) and Large Cap Growth, Large Cap Value, and Foreign Large Value (approximately 75% of managers underperformed). While this may cause investors to question active management all together, it is important to recognize that market cap weighted indexes are similar to price momentum strategies in that the best performing securities continue to rise to the top and become a larger portion of the index, so essentially, a smaller number of larger securities tend to drive the performance of the index. For example, in 2016, approximately 80% of the performance of the S&P 500 Index can be attributed to approximately 20% of the securities in the Index. Active managers tend to look less like their benchmarks as indexes become more expensive, valuation dispersions widen, stock correlations decline, and the market begins to present more idiosyncratic (stock specific) opportunities. Active managers are also less inclined to overweight the largest securities in an index because they already represent a large portion of their portfolio. Given that the price momentum nature of indexes has persisted for some time now (with a smaller portion of the index driving performance higher), we believe that this trend is likely to revert sooner than later, which we would expect to work to the benefit of active management.

2) The U.S. Election Caused Pronounced Short-Term Price Reactions in Several Segments of Global Securities Markets, Which Led to Underperformance of Most Multi-Asset Portfolios Relative to U.S. Equities

Exhibit 2 below demonstrates how pronounced the post-election move in U.S. equities was relative to a diversified multi-asset portfolio, as represented by the S&P Growth Target Risk Index (multi-asset mix comprised of approximately 60% stocks/40% bonds). The exhibit also provides a good perspective of how diversification is generally expected to dampen volatility, particularly in times of market stress. For example, investors may not recall what the downturn of January 2016 felt like, so it is important to remind clients why diversification is beneficial.

Exhibit 2: S&P 500 Index Total Return vs. S&P Growth Target Risk Index Total Return

Source: Bloomberg data

In addition to the outperformance of U.S. equities, there were very specific market reactions that impacted portfolios. While the overall thematic contributors to the underperformance of multi-asset portfolios was consistent across risk profiles, the magnitude of the impact varied considerably depending on the the actual level of risk (i.e., Conservative vs. Aggressive). We provide a brief description of three major market reactions below which were most impactful to performance post election period, with an explanation of the implication on multiasset portfolios.

Market Reaction Implication on Multi-Asset Portfolios
Higher inflation expectations and significantly higher bond yields, which weighed heavily on the performance of bonds and many income-oriented securities. Conservative, Moderately Conservative, and Moderate Allocation portfolios were generally the most negatively impacted, as bonds represent a sizable allocation in these strategies, offsetting the positive returns in equities.
Rally in the U.S. dollar, which weighed heavily on the returns of Non-U.S. equities in dollar terms, particularly for emerging market equities. Moderate, Moderately Aggressive, and Aggressive portfolios were the most negatively impacted. Most multi-asset portfolios take a global approach, and while Non-U.S. equities delivered positive returns, they largely underperformed U.S. equities.
Pronounced rally in U.S. cyclical, namely Industrials, Financials, and Energy stocks, representing approximately 32% of the S&P 500’s return, on the prospect of more growth-friendly policies and lighter regulations. Moderate, Moderately Aggressive, and Aggressive portfolios were generally the most negatively impacted as Non-U.S. equities represent a larger allocation in these strategies. While U.S. equity strongly outperformed other asset classes, active U.S. equity managers were unable to take advantage of this narrowly driven rally, lagging behind the broad U.S. equity indices.

3) Stay the Course—Diversification Facilitates Consistency

We recognize that the current market environment may cause clients to question the benefits of diversification and active management. We continue to promote diversification with the goals of dampening the volatility of our client portfolios and delivering compelling long-term risk-adjusted returns. Exhibit 3 below shows the calendar year performance of a broad range of asset classes. The value of holding a diversified portfolio has been consistently illustrated over the past 10 calendar years. On a year-by-year basis, the ranking of each asset class varies dramatically from best to worst, while the Diversified Portfolio (yellow) consistently delivers a more stable result, and has provided even more compelling results in down markets (i.e., 2008). Given more rich valuations and the fact that U.S. equities (Large Caps and Small Caps) have outperformed the Diversified Portfolio over the past five calendar years, we believe that staying the course with a diversified portfolio is likely to lead to more stable returns going forward.

Exhibit 3: Historical Asset Class Returns

Click here or image for larger view

Importance of Diversification

The above Diversified Portfolio is comprised of the Russell 3000 Index: 35.00%; MSCI - EAFE Index ($Net): 15.00%; MSCI - Emerging Markets Index ($Net): 4.00%; FTSE EPRA/NAREIT - Developed Index: 4.00%; Bloomberg Commodity - Commodity Index (Total Return): 2.00%; Barclays - U.S. Aggregate Index: 28.00%; Barclays - U.S. TIPS Index: 4.00%; Barclays - U.S. High Yield Index: 4.00%; Citi - Non U.S. Govt Bond Index ($): 4.00%.

Important Information
Wilshire Funds Management (“WFM”) is a business unit of Wilshire Associates Incorporated (“Wilshire®”).

Wilshire is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders.

This material contains confidential and proprietary information of Wilshire. It may not be disclosed, reproduced or redistributed, in whole or in part, to any other person or entity without prior written permission from Wilshire Funds Management.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice. Past performance does not guarantee future returns. This material may include estimates, projections, and other “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented.

This material represents the current opinion of Wilshire based on sources believed to be reliable. Wilshire assumes no duty to update any such opinions. Wilshire gives no representations or warranties as to the accuracy of such information, and accepts no responsibility or liability (including for indirect, consequential or incidental damages) for any error, omission, or inaccuracy in such information and for results obtained from its use. Information and opinions are as of the date indicated, and are subject to change without notice.

©2017 Wilshire Associates Incorporated. All rights reserved.

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