European Secession Votes and Market Implications: Scotland

Stuart P. Quint, CFA, Senior Investment Manager and International Strategist

This first blog in a two-part series will examine the Scottish secession vote coming in September and the potential implications for financial markets. The second blog will delve into the Catalan vote in November.

“There is the real possibility of one or several national divorces being initiated in Western Europe in 2014,” opines Nicholas Siegel, program officer at the Transatlantic Academy, a U.S.-European think-tank based in Washington.[1]

Secession votes will be held in the UK in September over the future of Scotland and in Spain in November over the future of Catalunya. It appears unlikely that either will result in a real separation of the regions from these nations. However, financial markets should still monitor the progress of these votes. Markets appear to discount a rejection of secession. If voters in one of these regions were to vote for secession, that could trigger near-term volatility. Regardless, these votes highlight fragility in the fabric of the European Union that warrants monitoring.

Voters in Scotland will elect whether to remain a part of the United Kingdom or to secede and claim independence. A “Yes” vote would lead to binding negotiations between the Scottish and UK Governments for eventual secession. Recent polls suggest pro-independence voters will not succeed as a plurality of voters leans against independence.[2]

In the event of a vote for independence, complications both for the UK and Scotland could ensue. The size of the economy and population of Scotland is less than 10% of the UK; yet, these statistics conceal a few hurdles. Much of the energy produced within the UK falls within Scottish jurisdiction. Many UK financial services companies are based in Scotland (though the majority of their revenues derive from outside Scotland). Moreover, the Bank of England has stated that Scotland would have to use its own currency instead of the British Pound Sterling.

The costs of independence could bring with them financial turmoil at least for an independent Scotland. However, the UK itself might not go unscathed as the British Pound Sterling is a reserve currency that could lose support. Major corporations, such as Standard Life, could relocate from Scotland back to the UK

Even a “No” vote, though, does not necessarily put an end to the matter. A narrow vote could give way to a second future vote and have repercussions for future votes on the UK remaining in the EU and general elections in 2015. A “No” vote that fails to win overwhelmingly could potentially accelerate the timing of the referendum for whether the UK remains in the EU.

In terms of financial markets, the closest recent comparable is Canada, which experienced two failed referenda regarding the secession of Quebec in 1980 and 1995. In both instances, markets did not underperform global markets leading into and post the referenda. Although markets shrugged off the referenda, over time many large Canadian corporations relocated their headquarters out of Quebec.

[1] “Is Secession the Answer? The Case of Catalonia, Flanders, and Scotland”, December 2, 2013 retrieved on http://knowledge.wharton.upenn.edu/article/secession-answer-case-catalonia-flanders-scotland/ .

[2] Lukyano Mnyanda, “Scots Anti-Independence Camp Gains in Poll amid Pound Doubts”, August 13, 2014, Bloomberg News.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Investment Insights Podcast – August 13, 2014

Bill Miller, Chief Investment Officer

On this week’s podcast (recorded August 11, 2014):

What we like: Fair amount of correction in the equity markets around the world; small correction also in U.S.

What we don’t like: U.S. stock market will likely correct closer to their 10% before the Fed finishes bond-buying program in October

What we’re doing about it: Hedging more during seasonally-weak time period; mindful of midterm elections

Click the play icon below to launch the audio recording or click here.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Monthly Market and Economic Outlook: August 2014

Amy Magnotta, CFA, Senior Investment Manager, Brinker Capital

After pushing higher for most of July, the U.S. equity markets fell -2% on the last day to end the month in the red. Continued geopolitical concerns, a debt default in Argentina and a higher than expected reading on the Employment Cost Index could have provided a catalyst for the sell-off. Investor sentiment levels were elevated in July, so it is not surprising to have any bad news lead to a short-term pull-back in the equity markets. However, we believe equity markets are biased upward over the next six to twelve months and further weakness could be a buying opportunity.

U.S. small cap stocks have significantly lagged large caps so far this year. In July the small cap Russell 2000 Index declined -6.1%. The Russell 2000 is down -3.1% for the year-to-date period, compared to the +5.5% gain for the Russell 1000 Index. From a style perspective, value lagged growth in July but remains solidly ahead for the year-to-date period.

Developed Europe significantly lagged the U.S. equity markets in July, but Japan was able to deliver a positive return. Emerging markets continued their rally in July, gaining +2.0% for the month. Emerging markets have gained +8.5% through the first seven months of the year, well ahead of developed markets. Countries that struggled in 2013 due to the Fed’s taper talk, like India and Indonesia, have been very strong performers, while negative performance in Russia has weighed on the complex. The U.S. dollar has shown recent strength versus both developed and emerging market currencies.

U.S. Treasury yields edged slightly higher in July. The 10-year yield has fallen 56 basis points from where it began the year (as of 8/7/14), while the 2-year part of the yield curve has moved up eight basis points. As a result, the yield curve has flattened between the 10-year and 2-year tenors; however, it remains steep relative to history. While sluggish economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, relative value could also be a factor. A 2.4% yield on a 10-year U.S. Treasury looks attractive relative to a 0.5% yield on 10-year Japanese government bonds, a 1.1% yield on 10-year German bonds, and a 2.6% yield on Spanish 10-year sovereign debt.

All taxable fixed income sectors were flat to slightly negative on the month. High yield fared the worst, declining -1.3% as spreads widened 50 basis points. Municipal bonds were slightly positive for the month and continue to benefit from a positive technical backdrop with strong demand for tax-free income being met with a lack of new issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

• Global monetary policy remains accommodative: Even with quantitative easing slated to end in the fall, U.S. short-term interest rates should remain near-zero until 2015 if inflation remains contained. The ECB and the Bank of Japan are continuing their monetary easing programs.
• Global growth stable: U.S. growth rebounded in the second quarter. Outside of the U.S., growth has not been very robust, but it is still positive.
• Labor market progress: The recovery in the labor market has been slow but steady. The unemployment rate has fallen to 6.2% and jobless claims have fallen to new lows.
• U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.
• Less drag from Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Fiscal drag will not have a major impact on growth in 2014, and the budget deficit has also declined significantly.

Risks facing the economy and markets remain, including:

• Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing will end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. Should inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike. Despite the recent uptick in the CPI, the core Personal Consumption Expenditure Price (PCE) Index, the Fed’s preferred inflation measure, is up only +1.5% over the last 12 months.
• Election Year/Seasonality: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections. In addition, August and September tend to be weaker months for the equity markets.
• Geopolitical Risks: The events in the Middle East and Russia could have a transitory impact on markets.

Risk assets should continue to perform over the intermediate term as we expect continued economic growth; however, we could see increased volatility and a shallow correction as markets digest the end of the Federal Reserve’s quantitative easing program. Economic data, especially inflation data, will be watched closely for signs that could lead the Fed to tighten monetary policy earlier than expected. Equity market valuations look elevated, but not overly rich relative to history, and maybe even reasonable when considering the level of interest rates and inflation. Investor sentiment, while down from excessive optimism territory, is still elevated, but the market trend remains positive. In addition, credit conditions still provide a positive backdrop for the markets.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index

Teaching Moments: Help Clients Shake the Emotional Hangovers

Sue Bergin, President, S Bergin Communications

While the I-make-a-decision-and-forget-about-it approach might have worked for Harry S. Truman, it does not describe the vast majority of today’s investors.

According to our recent Brinker Barometer advisor survey[1], only 22% of advisors clients embrace Truman’s philosophy. The vast majority of clients suffer from emotional hangovers after periods of poor performance. They let the poor investment performance impact future decisions. Sometimes, it is for the better. In fact, 31% of clients made wiser decisions after learning from poor investment performance. Nearly half of the respondents, however, claimed that emotions cloud the investment decision following poor performance.

Another recent study, led by a London Business School, sheds light on how advisors can increase satisfaction by helping clients make peace with their decisions. According to the research, acts of closure can help prevent clients from ruminating over missed opportunities. To illustrate the point, researchers simply asked participants to choose a chocolate from a large selection. After the choice had been made, researchers put a transparent lid over the display for some participants but left the display open for others. Participants with the covered tray were more satisfied with their choices (6.30 vs. 4.78 on a 7 point scale) than people who did not have the selection covered after selecting their treat.

While the study was done with chocolate and not portfolio allocations, behavioral finance expert Dr. Daniel Crosby says that it can still provide useful insights on helping clients avoid what Vegas calls, “throwing good money after bad,” and psychology pundits refer to as the “sunk-cost fallacy.”

“Many clients are so averse to loss that they will follow a bad financial decision that resulted in a loss with one or more risky decisions aimed at recouping the money. If you detect that a client is letting emotional residue taint future decisions you should counsel them to consider the poor performance as a lesson learned. This will allow the client to grow from the experience rather than doubling the damage in a fit of excessive emotionality,” Crosby explains.

[1] Brinker Barometer survey, 1Q14. 275 respondents

The views expressed are those of Brinker Capital and are for informational purposes only.

Investment Insights Podcast – July 1, 2014

Bill Miller, Chief Investment Officer

On this week’s podcast (recorded June 30, 2014), Bill addresses some of the things we don’t like first, then gives greater insight into what we are doing about it:

What we don’t like: Interest rates are stubbornly low; expectations were that they would rise over the first-half of the year; low interest rates hurt retirees ability to generate income

What we like: How we are handling this financial repression

What we are doing about it: Emphasizing three themes in fixed income: yield, shorter maturity bonds, and inclusion of absolute return

Click the play icon below to launch the audio recording or click here

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Reach Out in Good Times and Bad

Sue Bergin, President, S Bergin Communications

It’s no secret that clients like to hear from their advisors. In fact, failure to communicate is one of the top five reasons why clients become dissatisfied with their advisor. According to a Spectrum study, 40% of clients said they consider leaving when the advisor makes them do all the work (make all the calls).[1]

A recent study by Pershing, however, shows that advisors do make the calls—when they have bad news. Here are some of the key findings when it came to communication choices.

• 58% of the advisors contacted clients during market downturns, yet only 39% reached out to discuss market gains.
• 68% of advisors reached out to clients when personal investments declined, while only 53% initiated contact with the client in instances when personal investments increased in value.[2]

How News is Delivered
The telephone is the most frequently used communication vehicle for both good and bad investment performance news. A quarter of the advisors surveyed used email and face-to-face meetings to communicate market losses, while 58% of the advisors picked up the phone. The only type of communication that happened more frequently in person than any other message was in the area of education. 52% of advisors said that they scheduled face-to-face meetings to educate clients while 48% did so over the telephone.

“No News is Good News” Applies Better to Weather than Client Relationships
Communication work is fundamentally about two things: trust and relationships. Good communication can strengthen relationships and deepen trust while poor communication can have the opposite effect. The “no news is good news” approach many advisors seem to take is problematic for a few reasons. It robs the advisor of the opportunity to score relationship-building points. It also increases the risk of clients feeling neglected. Finally, it makes it more difficult for the advisor to identify opportunities proactively because they become somewhat out-of-touch with what is happening in their clients’ lives.

[1] http://www.onwallstreet.com/gallery/ows/client-switching-advisor-top-five-reasons-2681390-1.html

[2] The Second Annual Study of Advisory Success: A New Age of Client Communications and Client Expectations, Pershing.

The views expressed are those of Brinker Capital and are for informational purposes only.

Investment Insights Podcast – May 28, 2014

Bill Miller, Chief Investment Officer

On this week’s podcast (recorded May 22, 2014), Bill gives a review on the controversial book, Capital in the Twenty-First Century by Thomas Piketty:

What we like: Emphasis on returns to capital (savings); savers will continue to be rewarded.

What we don’t like: Modern-socialistic state belief using high tax rates in order to deal with societal inequalities.

What we are doing about it: We encourage opening savings accounts for children and grandchildren; fund 401(k)s to the max; watching if some of the societal inequalities as outlined by Piketty are dealt with sooner than later.

Click the play icon below to launch the audio recording or click here.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Embracing Innovation: Envestnet Advisor Summit Wrap-up

Greg Vradenburg, Managing Director, Investment Services

Last week we were honored to be one of the Premier Sponsors at the Envestnet Advisor Summit in Chicago. The theme of the event was “the next big thing” and it was evident everywhere. Envestnet Chairman and CEO Judson Bergman opened up the conference by talking about how advisors need to be disruptive innovators in order to succeed and overcome looming industry challenges. He stressed the importance of embracing technology, building brand and perfecting marketing and reminded us of past giants such as MySpace, BlackBerry and Blockbuster that did not take these steps and were not aware of happenings in the new markets and seemingly fell behind.

Envestnet President Bill Crager also talked about how the role of the advisor will become increasingly important in the next five years. As older advisors begin to exit the business, Crager projects that the average advisors assets will increase from $90 million today to $145 million in 2020. (Source: “9 Takeaways from the Envestnet Advisor Summit”, Financial Planning, May 20, 2014)

Conference attendees were also introduced to the Envestnet Institute, an online advisor education portal that features white paper, videos and webinars. Brinker Capital is proud to be one of the contributing content partners for this exciting new unified education portal.

Finally we were pleased by the informative “Liquid Alternatives Panel” that our CIO, Bill Miller, participated in. All panelists agreed the education around alternatives is key for both clients and advisors. Alternatives firmly fill a role in a portfolio by providing greater portfolio diversification as well as access to unique opportunities and strategies; however, they are just a piece of the overall pie.

Our thanks go out to Envestnet for hosting such a great event that allowed us to network with colleagues, investment professionals and Envestnet representatives! We look forward to next year’s Advisor Summit!

Brinker Capital at the Envestnet Advisor Summit 2014 Conference

Jean Lynch, Managing Director

Brinker Capital is pleased to be one of Envestnet’s Platinum Sponsors for 2014 and to be supporting the Advisor Summit 2014 for the third year in a row! Envestnet’s Advisor Summit is a great venue to network with our clients who access our investment strategies on the Envestnet platform, other investment professionals, and the Envestnet team. This year’s conference is focused on “The Next Big Idea” and the agenda is packed with innovative sessions that will help advisors elevate their business to the next level.

Brinker Capital’s latest “Big Idea” is the introduction of three new 40-Act liquid alternative mutual funds that leverage the strength of our 25+ years on investment management insight and expertise and more than a decade of embracing alternative investments.  These funds – Crystal Strategy Absolute Income Fund, Crystal Strategy Absolute Return Fund, and Crystal Strategy Leveraged Alternative Fund – are designed to mirror the investment strategy of our Crystal Strategy suite of global macro funds.  While each of these funds have their own specific investment strategies and places within an investment portfolio, they do share certain characteristics including broad asset class exposure, diverse strategies, highly-focused stock selection, portfolio hedging and risk management.  For more information on the funds visit, www.crystalstrategyfunds.com.

If you happen to be at the Advisor Summit, be sure to attend the Liquid Alts and Their Growing Role in Portfolio Construction panel on Thursday, May 15 from 2:00pm – 3:00pm to hear from Brinker Capital’s Chief Investment Officer, Bill Miller, as he discusses how our approach to incorporating liquid alternatives into our investment philosophy may help advisors potentially create better outcomes for clients.

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Important Information
Please note that investing in alternative strategies involves a high level of risk and is not suitable for all investors. The Crystal Strategy Funds are subject to investment risks, including possible loss of the principal amount invested and therefore are not suitable for all investors. The Funds may not achieve their objectives. Diversification does not ensure a profit or guarantee against loss.

An investor should carefully consider investment objectives, risks, charges, and expenses before investing. To obtain this and other information about the Crystal Strategy Funds, see the Prospectus available from your financial advisor, visit http://www.crystalstrategyfunds.com, or call (855) 572-1722. Read the Prospectus carefully before investing.

The Crystal Strategy Family of Funds is distributed by ALPS Distributors, Inc., 1290 Broadway, Ste. 1100, Denver, CO 80203.  Separately managed accounts and related investment advisory services are provided by Brinker Capital. ALPS is not affiliated with Brinker Capital and does not distribute separately managed accounts. The Crystal Strategy Family of Funds is new and has limited operating history.

Not FDIC Insured – No Bank Guarantee – May Lose Value.

Investment Risks
Alternative Investment Risk. The Team will seek to manage the Fund to balance the potential risks and rewards that we believe are present at any given time and given market. Due to the use of leverage, the Fund will be more aggressive in nature. Likewise, due to the underlying investment process, we believe that there is a strong likelihood that the Fund will perform notably different than traditional strategies with comparable levels of volatility. Similarly, despite the ability to hedge and shift Fund exposures, due to the leveraged nature of the Fund, risks will be magnified and compounded.

Asset Allocation Risk. Portfolio management may favor one or more types of investments or assets that underperform other investments, assets, or securities markets as a whole. Anytime portfolio management buys or sells securities in order to adjust the Fund’s asset allocation, this adjustment will increase portfolio turnover and generate transaction costs.

Borrowing Risk. Borrowing creates leverage. It also adds to Fund expenses and at times could cause the Fund to sell securities when it otherwise might not want to.

Concentration Risk – Investment Companies. Any investment company that  concentrates in a particular segment of the market (such as commodities, gold-related investments, infrastructure-related companies and real estate securities) will generally be more volatile than a fund that invests more broadly. Any market price movements, regulatory or technological changes, or economic conditions affecting the particular market segment in which the investment company concentrates will have a significant impact on the investment company’s performance. While the Fund does not concentrate in a particular industry, it may hold a significant position in an investment company, and there is risk for the Fund with respect to the aggregation of holdings of investment companies. The aggregation of holdings of investment companies may result in the Fund indirectly having significant exposure to a particular industry or group of industries, or in a single issuer. Such indirect concentration may have the effect of increasing the volatility of the Fund’s returns. The Fund does not control the investments of the investment companies, and any indirect concentration occurs as a result of the investment companies following their own investment objectives and strategies.

Derivatives Risk. The Fund’s use of derivatives (which may include options, futures, swaps and credit default swaps) may reduce the Fund’s returns and/or increase volatility. A risk of the Fund’s use of derivatives is that the fluctuations in their values may not correlate perfectly with the overall securities markets. Additional, derivatives are subject to liquidity risk, interest rate risk, market risk, credit risk and management risk.

Short Sale Risk. If the Fund sells a security short and subsequently has to buy the security back at a higher price, the Fund will lose money on the transaction. Any loss will be increased by the amount of compensation, interest or dividends and transaction costs the Fund must pay to a lender of the security. The amount the Fund could lose on a short sale is theoretically unlimited (as compared to a long position, where the maximum loss is the amount invested). The use of short sales, which has the effect of leveraging the Fund, could increase the exposure of the Fund to the market, increase losses and increase the volatility of returns.

Investment Objectives
Absolute Income Fund:  The Fund seeks to provide current income and downside protection to conventional equity markets, with absolute (positive) returns over full market cycles as a secondary objective.

Absolute Return Fund:  The Fund seeks to provide positive (absolute) return over full market cycles.

Leveraged Alternative Fund:  The Fund seeks to provide long-term positive absolute return with reduced correlation to conventional equity markets as a secondary objective.

Bridging the Alternative Investment Information Gap

Sue Bergin, President, S Bergin Communications

The groundswell of interest in alternative investments continues to build, creating a thirst for clear, comprehensive and client-facing educational materials.

According to Lipper, alternative mutual funds saw the biggest percentage growth of any fund group, with assets under management increasing 41% to $178.6 billion in 2013. A recent report by Goldman Sachs projects liquid alternatives are in the early stage of a growth trend that could produce $2 trillion in assets under management in the next 10 years. In order for this to happen, however, investors must gain a better understanding of how alternative investments work, how they function within a portfolio, and where potential benefits and risks could occur.[1]

Alternative investment strategies are a separate beast than the traditional methods of investing and traditional asset classes that most investors are familiar with. From divergent performance objectives, to the use of leverage, correlation to markets, liquidity requirements and fees, a fair amount about alternatives is different from traditional investments. Understandably, investors have many questions before they can decide whether to and how much of their portfolio to dedicate to alternative investments.

The task of educating investors about alternatives is falling largely on the shoulder of the advisory community. Well over half (60%) of the high-net-worth investors recently surveyed by MainStay Investments, indicated financial advisors as the top resource for alternative investment ideas. Trailing advisors was internet-based research (41%), research papers and reports (35%), and financial service companies (30%).[2]

Historically, advisors have shied away from recommending alternative investment strategies because they are too difficult to explain. The conundrum they now face is that 70% of those advisors surveyed also acknowledge the need to use new portfolio strategies to manage volatility and still seek positive.[3]

It’s important that advisors start to value the use of alternatives and find ways to bridge the information gap for investors. The good news is that investors have tipped their hands in terms of what they really want to know. According to the MainStay survey, clients want more information in the following areas:

 

• Explaining the risks associated with alternative investments (73%)
• Learning about how alternatives work (71%)
• Finding out who manages the investments (54%)
• Charting how alternatives affect returns (46%)

[1] http://www.imca.org/pages/Fundamentals-Alternative-Investments-Certificate

 [2] “HNW Investors Turn to Advisors For Alternative Investment Guidance,” InsuranceNewsNet, April 3, 2014.

[3] “Few advisers recommend alternative investments: Respondents to a Natixis survey said that they stick to strategies that can be explained to clients more easily,” InvestmentNews, October 24, 2013

The views expressed are those of Brinker Capital and are for informational purposes only.