Investment Returns as of December 31, 2020
1-3 Year Treasury Bonds
|U.S. Aggregate Bonds||0.7%||7.5%||5.3%||4.4%||3.8%|
|Global Aggregate Bonds (USD – Unhedged)||2.7%||8.9%||4.8%||4.7%||2.9%|
|U.S. Municipal Bonds||1.8%||5.2%||4.6%||3.9%||4.6%|
|U.S. High-Yield Bonds||6.5%||6.2%||5.9%||8.4%||6.6%|
|U.S. Leveraged Loans||3.8%||3.1%||4.0%||5.2%||4.3%|
|U.S. Inflation-Linked Bonds||1.6%||11.5%||6.1%||5.3%||4.0%|
|Global Equity (USD)||14.8%||16.8%||10.6%||12.8%||9.7%|
|U.S. Large-Cap Equity||12.1%||18.4%||14.1%||15.2%||13.9%|
|U.S. Small-Cap Equity||31.4%||19.9%||10.2%||13.2%||11.2%|
|Non-U.S. Developed Equity (USD)||16.1%||8.3%||4.8%||8.0%||6.0%|
|Emerging Markets Equity (USD)||19.8%||18.7%||6.5%||13.2%||4.0%|
|Non-U.S. Developed Equity (Local)||11.4%||1.3%||3.5%||6.3%||7.3%|
|Emerging Markets Equity (Local)||16.1%||19.5%||8.5%||13.0%||7.0%|
|Long/Short Equity Hedge Funds||14.4%||17.4%||7.4%||8.2%||5.3%|
|* Annualized return figures
Past returns do not guarantee future results
2020 was a difficult and emotional year for all as a global pandemic ravaged the economy, thrusting it into the deepest recession on record and causing unprecedented pain for families around the world, with roughly 99.9 million cases of COVID-19 and 2.15 million deaths as of this writing. As we reflect on this trying period, we are grateful for the relationships we have with our clients, investment managers and colleagues. To all of you, we thank you for your support and continued confidence. During the early days of the pandemic, we would have been hard pressed to predict that the markets would generate such strong returns in 2020, but positive developments, including a highly accommodative Federal Reserve and the prospects for a COVID-19 vaccine that would serve to return the world to normalcy, buoyed the markets. Through it all, we held steadfast to our disciplined investment philosophy, carefully reunderwriting portfolios and confidently investing in the businesses that we believed would not only survive, but thrive.
What a year 2020 was! A recap of some of the macro and political developments of 2020 reminds us of the tumultuous times we all lived through – and perhaps have chosen to forget. The timeline of events is breathtaking when viewed together on one page.
- January 5: China announces that the pneumonia cases in Wuhan are not SARS or MERS.
- January 31: The Senate votes to acquit President Trump on two articles of impeachment.
- February 11: The World Health Organization names the new coronavirus disease: COVID-19.
- March 2: The Federal Reserve cuts interest rates by 50 basis points, signaling that policymakers recognize the potential economic significance of the situation.
- March 9: Oil experiences its second-largest price drop on record, with WTI price falling 24.6% after tensions rise between Russia and Saudi Arabia.
- March 11: The coronavirus outbreak is declared a global pandemic.
- March 23: The S&P 500 declines to trough levels, falling 34% from a February 19 peak.
- March 23: The Federal Reserve announces measures to support the economy, including purchasing U.S. Treasuries and agency mortgage-backed securities and expanding the Money Market Mutual Fund Liquidity and Commercial Paper Funding Facilities.
- March 26: Unemployment insurance claims reach historic levels. (For the week ending March 21, initial unemployment insurance claims rise to over 3.3 million.)
- March 27: The CARES Act is signed into law, providing nearly $2 trillion in relief.
- April 9: The Federal Reserve rolls out a $2.3 trillion emergency lending effort to bolster local government and small and medium-sized businesses.
- May 25: George Floyd is killed, sparking a wave of protests and riots across the U.S.
- July 21: EU leaders approve unprecedented €750 billion recovery fund.
- August 18: Fires begin in California, burning thousands of acres and killing 16 people.
- August 28: Japanese Prime Minister Shinzo Abe steps down due to health problems.
- September 15: President Trump announces historic normalization agreements between Israel, the UAE and Bahrain.
- September 18: Supreme Court Justice Ruth Bader Ginsburg passes away.
- October 20: The Trump administration sues Google in what is the largest antitrust case.
- October 26: Amy Coney Barrett is confirmed to succeed Ginsburg.
- November 3: Joe Biden is elected as the 46th president of the United States.
- December 11: The FDA authorizes the COVID-19 Pfizer-BioNTech vaccine for emergency use in the U.S.
- December 18: The FDA authorizes the Moderna COVID-19 vaccine for emergency use in the U.S.
- December 24: Britain and the EU strike a trade agreement, settling a Brexit negotiation that stretched over four years.
- December 27: The Coronavirus Response and Relief Supplemental Appropriations Act is signed into law.
If the first few weeks of January 2021 are any indication of things to come, we may continue to live in interesting times. On January 6, the Democrats swept the Republicans in the Georgia Senate runoff elections, and Congress is now split 50-50 between the two parties. The same day, in an unprecedented turn of events, President Biden’s victory was derailed for several hours after a mob of protesters stormed the U.S. Capitol. In the end, democracy persevered, and Congress certified that Joseph Biden and Kamala Harris would be the next U.S. president and vice president, respectively. With Congress now equally split, and the tiebreaking vote held by Vice President Harris, it is likely that the Biden administration will have the leverage to pass much of its policy agenda, which is expected to include a stimulus package, tax reform and the promotion of green energy programs. We will be following these developments carefully and will update you on changes as they occur. However, as we think about the year ahead, we continue to believe that the best strategy for investors is to focus on the fundamentals of the high-quality businesses in which our managers are investing, rather than trying to anticipate the impacts of expected policy changes.
To quote one of our managers: “We’re not deluding ourselves into thinking that the intersection of COVID-19, global political tensions, and government and central bank actions are going to have a calming effect on global markets. Regardless, we believe our focus on fundamentals, particularly earnings and earnings stability, will provide direction as we look to compound our clients’ capital.”
Looking back at 2020, it is interesting that the year’s best-performing asset was bitcoin. We have memories of 2017, when bitcoin was up a whopping 1,403% and then proceeded to decline by 74% in 2018. We have been asked many times if we will be investing in bitcoin or other cryptocurrencies. While the core technologies of blockchain and cryptography are likely valuable, we believe it is difficult, if not impossible, to determine which cryptocurrencies will succeed or fail over the long term and, with no associated cash flows, what the real intrinsic values are. We won’t be recommending an allocation to bitcoin in our policy portfolios; however, we do believe it is imperative to stay informed of new developments, securities and investment structures so that we can assess the evolving investment landscape and take advantage of opportunities as they arise.
In this vein, we have seen the rapid rise of a relatively new speculative asset called a SPAC, which stands for special purpose acquisition company. A SPAC is a shell company that a sponsor investor organizes and takes public in an initial offering. The company has no operations; it simply holds cash and typically has two years to find a private company to acquire. The SPAC’s sponsor invests some of his own capital but takes an additional ~20% interest in the entity at a nominal price. Investors typically pay $10 per share for the SPAC and have the right to not participate in the acquisition and redeem their shares at the price they paid, plus interest as well as keeping any warrants or rights for free. The problem with the structure is that it favors the sponsor and not the investor. Investors who remain in SPACs have generally done poorly, as the sponsors’ free shares and the free warrants dilute their returns. Even investors that redeem their shares have to think about the opportunity cost of holding a SPAC with interest rates being so low. Unsurprisingly, SPACs have become the darlings of hedge funds, but we remain wary of these speculative securities. As always, we promise you we will not invest in fads simply because others are doing so, but we will scour the universe for interesting investments and only make allocations when we know what we own and why we own it.
All global equity benchmarks generated positive returns for calendar year 2020. If an investor looked at his statement only at calendar year-end, it would appear to have been a benign year in the markets. However, as the nearby chart illustrates, the markets went on a rollercoaster ride that peaked on February 19 and troughed on March 23, only to recover and surpass prior highs by August.
|MSCI EM ($)||(31.2)||73.5||18.3|
|MSCI EAFE ($)||(32.7)||61.4||8.3|
|Past performance does not guarantee future results.|
We have discussed in prior articles the potential reasons for this stellar run despite the severity of the pandemic and its economic impact. While there is no definitive answer, it is likely that the stock market, which is a discounting machine, was responding to expectations of what economic and financial conditions would be like in 12 to 18 months, instead of reacting to what was happening at the time. The markets may also have been responding to the Federal Reserve’s aggressive actions, as well as the $2 trillion of stimulus, both of which were extremely supportive of equity markets.
For the year, small-cap equities slightly outperformed their large-cap peers, as measured by the Russell 2000 and S&P 500, respectively. Through November 30, small-cap equities still lagged, but a December return of 8.7% for the Russell 2000 compared with a more modest 2.5% return for the S&P 500 pushed small caps ahead, and the Russell 2000 ended the year up 19.9%, outpacing the S&P 500 by 150 basis points. Over a 10-year period, large-cap equities were still the best performers, but last year may be the beginning of the reversal of a long trend and confirmation that the small-cap equity premium still exists.
Non-U.S. developed equity returns trailed U.S. equities once again, although they still generated respectable returns of 8.3%. Currency helped returns as the dollar weakened during the year, boosting the local return, which was just 1.3%. Emerging markets equity fared better, generating a return commensurate with U.S. large-cap equities, with much of the return coming from China. Given the more reasonable valuations in non-U.S. equities, their medium- to long-term outlook could well be favorable.
Turning to sector returns, there was quite a bit of dispersion during the year. The nearby chart shows the sector returns for the S&P 500.
2020 S&P 500 Sector Performance
As of January 15, 2021.
Past performance does not guarantee future results.
As illustrated, technology stocks were the best performers in 2020. The dominance of technology stocks, particularly Facebook, Amazon, Apple, Microsoft and Google (FAAMG), continued as the pandemic accelerated online consumption and the new normal of remote work created a tailwind for many of these businesses. Information technology was up 43.9%, and the FAAMG stocks comprised 20.8% of the index and returned an average of 53%, contributing 10.4% of the S&P 500’s 18.4% return. This dynamic persisted throughout the first three quarters of the year, despite a slight reversal in the month of September that continued through the fourth quarter, which saw “big tech” sell off around heightened antitrust scrutiny and fears of potential regulation.
Bringing up the rear were energy, real estate and financials, as historically low oil prices put pressure on energy stocks and zero rates hurt financials, particularly banks. While we do not make top-down decisions to avoid sectors, given our emphasis on owning companies with superior business models, limited capital spending requirements and lower financial leverage, we have virtually no exposure to the energy sector and are substantially underweight financials, particularly banks. Our portfolios are overweight in the consumer-oriented and technology sectors, which have been strong performers during the year.
The Value vs. Growth Debate
One of the hotly debated topics in 2020 related to the extreme gap in performance between value and growth stocks. As shown in the following table, the S&P 500 Growth Index outperformed the S&P 500 Value Index by 33.5% in 2020 and has outperformed over the past four years.
||S&P 500 Value||S&P 500 Growth|
As of January 15, 2021.
Past performance does not guarantee future results.
As we have written in the past, we believe that the value vs. growth construct is an arbitrary one that has no definitive meaning. However, we would be remiss if we didn’t acknowledge this stylistic dispersion and address it head on. Before we provide our views on this topic, it is important to understand how the market defines value and growth stocks. According to commonly used definitions, a value stock is one that has a lower-than-average valuation, as measured by various financial ratios, such as price-to-book or price-to-earnings (P/E), while a growth stock is expected to grow its per-share earnings, book value, revenues and cash flow at a higher rate than other businesses. In our opinion, all good investing is “value-oriented” investing. All businesses, whether fast- or slow-growing, cyclical or highly predictable, should be purchased at a discount to a conservatively calculated estimate of the business’s intrinsic value.1
Looking further into the dispersion between value and growth stocks, it is interesting to review the composition of the value and growth indices by sector. As shown in the table nearby, the value index includes a preponderance of businesses in energy, materials and financials, many of which are cyclical, that screen as value based on the metrics described. Unsurprisingly, the growth index has more technology, consumer discretionary and communication services businesses.
As noted, our portfolios own relatively little in energy and materials, and we are underweight financials, particularly banks – that is, the sectors that make up a substantial portion of the value index. Following on this observation, one might conclude that our portfolios are underweight “value” and overweight “growth.” Being intellectually curious, we have thought a lot about how our portfolios are positioned, and a few points are worth highlighting.
- All our managers seek to own businesses whose stocks are trading at substantial margins of safety.2 While our portfolios are underweight the cyclical businesses that traditionally fall into a “value” bucket based on the market’s narrow definition, we believe that we have a portfolio of “value-oriented” investments that can generate compelling long-term returns. We reject the notion of investing in stocks based on arbitrary backward-looking metrics, which do not give investors a true picture of a business’s future growth prospects and can be distorted by accounting conventions, such as not including intangibles in book value unless you acquire them.
- While all our managers focus on owning concentrated portfolios of competitively advantaged businesses that generate attractive returns on invested capital in excess of their cost of capital, operate in attractive industry structures and are run by long-term-oriented management teams that act like owners, each has a different approach to identifying such businesses. Some seek to invest in businesses that derive their value from their growth prospects, and others prefer to own more stalwart businesses with strong cash flow yields and steady growth. As a result, we believe our portfolios have ample diversification across businesses and economic drivers of value, and are therefore positioned to generate strong returns over time.
- We are comfortable not owning those businesses that are inconsistent with our strict investment criteria. Examples include many energy and materials companies, as well as some financials, where returns are dependent upon variables that are out of our control. While we recognize that investors can earn attractive returns by owning these businesses at the right time in a cycle, the timing of such is unpredictable, and we don’t consider that a repeatable way to generate compelling investment returns. Before the cycle turns, these stocks must be sold and taxes paid, thereby interrupting the compounding machine that is so important to growing wealth at above-average rates. We do, however, own some cyclical companies in distressed portfolios – when securities are trading at substantial discounts, and thus when returns are much less dependent on such factors as increases in commodity prices or interest rates.
2020 was an interesting year for fixed income markets. While 10-year Treasury rates had declined from a high of over 3% in 2018 to a range of 1.5% to 2.0% in the last half of 2019, there was still some yield available in risk-free fixed income at the start of 2020. As the COVID-19 pandemic took hold, however, the Federal Reserve again cut overnight interest rates to zero, and the 10-year Treasury quickly plunged to a new all-time low near 0.5% on March 9. While low rates were one effect the COVID-19 market disruption had on fixed income markets, March 2020 will also be remembered for unprecedented liquidity-driven selling that took place and the litany of Federal Reserve programs that were required to restore order to the markets.
Full-year 2020 returns do not do justice to the volatility that was witnessed during the year. Even CCC-rated high-yield bonds, which were down 22.7% in the first quarter of the year, recovered to post a 2.8% return for the year.3 High-yield credit spreads, which started the year at 3.4%, widened to 11% during March, before falling back to 3.6% by year-end as if nothing had happened. The Bloomberg Barclays U.S. Aggregate Index returned an impressive 7.5% for the year, a feat that it is unlikely to repeat in 2021 with a starting yield of 1.2%.
A recurring question from investors over the last decade has been what to do as a result of the zero interest rate environment. In contrast, for most of the 1990s and 2000s, 10-year Treasuries offered ample yield in the 4% to 8% range. As recently as November 1994, an investor could purchase a 10-year Treasury note at a 7.9% yield. In those days, investors could have yield, stability and liquidity just by owning risk-free obligations of the U.S. government. Now, you can earn a paltry yield of 4.2% in high-yield bonds, a volatile asset class where historically there have been annual credit losses in excess of 2%.
During times like these, it is important to go back to first principles and remember why we own fixed income in the first place. High-quality fixed income provides a source of portfolio stability in that, historically, it has been inversely correlated to equity markets. It is also a source of liquidity and can provide investors a small amount of yield. The fact that yields are lower than in the past does not negate fixed income’s role. Investors should regularly revisit their investment policy statement to determine that they have the right mix of equity and fixed income, but they should not stretch for yield in the part of their portfolio that is being counted on to provide stability and balance. Investors seeking yield should consider other strategies, including real estate and direct lending, but it is important to remember that these investments will likely not protect portfolios during a declining equity market.
Although we are fundamental bottom-up investors, it is our practice each year to develop capital market estimates for major asset classes. While we do not rely on these estimates for making investment decisions, we do utilize them to help frame expectations for returns and, in certain instances, to prioritize our research efforts during the year. Notably, these estimates are based on index returns and do not include estimates of manager alpha.
For 2021, our capital market estimates are in the below table.4
2021 Capital Market Expectations
|Asset Class||Pre-Tax Expectations
Geometric Return (CAGR)
Short-Duration Bond Funds
U.S. Investment Grade Taxable Bonds
U.S. Investment Grade Tax-Exempt Bonds
Non-Investment Grade Debt
U.S. Large-Cap Equity
U.S. Small/Mid-Cap Equity
Non-U.S. Developed Equity
Emerging Markets Equity
Private Real Estate
As we look ahead, we believe that markets are poised for moderate long-term growth. With U.S. large-cap equities producing strong returns over the last one-, three-, five- and 10-year periods, our forecast has come down. While we consider 7% to be a more “normal” long-term equity return, for the next 20 years we project a return of 5.6%. Most other equity sub-asset classes experienced declines in expected returns. In addition, while we expect yields to gradually rise over the next 10 years, with such a low yield environment, our projection for taxable fixed returns is 2.6%. Importantly, these estimates are for indices and not for individual stocks or bonds, and we remain excited about the opportunity for highly skilled active managers to generate compelling returns that exceed passive benchmarks.
1 Intrinsic value: BBH’s estimate of the present value of the cash that a business can generate and distribute to shareholders over its remaining life.
2 A margin of safety exists when we believe there is a significant discount to intrinsic value at the time of purchase.
3 Source: Bloomberg. ICE BofA CCC & Lower US Cash Pay High Yield Index.
4 Definitions – Yield: A measure of cash flow received from an investment over a given period expressed as a percentage of the investment’s value. For fixed income, the cash flow is composed of interest income; for equities, the cash flow is made up of dividend payments. Geometric return (CAGR): The compound annual growth rate (CAGR) is a geometric return that represents the single rate of return that an investment would have achieved by growing from its beginning balance to its ending balance assuming all cash flows were reinvested at the end of each year. Standard deviation: Measures the historical volatility of returns. The higher the standard deviation, the greater the volatility.
Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice.
This material contains “forward-looking statements” which include information relating to future events, projected future performance, strategies, expectations, and competitive environment, and regulations. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time the statements are made and/or BBH’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in, or suggested by, the forward-looking statements. Actual results or activities or actual events or conditions could differ materially from those estimated or forecasted in forward-looking statements due to a variety of factors, some of which may be beyond BBH’s control.
This material is not meant to be, nor shall it be construed as, a representation as to future performance, and no assurance, promise, or representation can be made as to actual returns. There can be no assurance that the investment objectives (including any return targets or projections) will be achieved or that any investor will not suffer losses or a decline in value.
References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations.
Issuers with credit ratings of AA or better are considered to be of high credit quality, with little risk of issuer failure. Issuers with credit ratings of BBB or better are considered to be of good credit quality, with adequate capacity to meet financial commitments. Issuers with credit ratings below BBB are considered speculative in nature and are vulnerable to the possibility of issuer failure or business interruption.
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