ASSET CLASS |
3 MONTHS |
1 YEAR |
3 YEARS |
5 YEARS |
10 YEARS |
|---|---|---|---|---|---|
FIXED INCOME |
|
|
|
|
|
1-3 Year Treasury Bonds |
-0.6% |
-0.6% |
2.0% |
1.6% |
1.1% |
U.S. Aggregate Bonds |
-0.1% |
-1.7% |
4.7% |
3.5% |
2.9% |
Global Aggregate Bonds (USD - unhedged) |
-1.1% |
-5.5% |
3.2% |
3.1% |
1.7% |
U.S. Municipal Bonds |
0.2% |
0.5% |
3.4% |
3.1% |
2.6% |
U.S. High Yield Bonds |
0.7% |
5.3% |
8.6% |
6.1% |
6.7% |
U.S. Leveraged Loans |
0.7% |
5.2% |
5.6% |
4.3% |
4.7% |
U.S. Inflation-Linked Bonds |
2.6% |
6.1% |
8.8% |
5.5% |
3.2% |
EQUITY |
|
|
|
|
|
Global Equity (USD) |
6.8% |
19.1% |
21.0% |
15.0% |
12.4% |
U.S. Large Cap Equity |
11.3% |
29.0% |
26.2% |
18.5% |
16.6% |
U.S. Small Cap Equity |
2.3% |
15.0% |
20.0% |
12.0% |
13.2% |
Nasdaq Composite |
9.1% |
23.0% |
34.6% |
25.2% |
21.1% |
Non-U.S. Developed Equity (USD) |
2.7% |
11.7% |
14.1% |
10.1% |
8.5% |
Emerging Markets Equity (USD) |
-2.0% |
-3.0% |
11.0% |
10.1% |
5.8% |
Non-U.S. Developed Equity (Local) |
4.1% |
19.4% |
13.9% |
8.9% |
10.6% |
Emerging Markets Equity (Local) |
-1.5% |
-0.6% |
12.1% |
10.7% |
8.4% |
REITs |
16.1% |
42.8% |
18.5% |
10.8% |
11.3% |
COMMODITIES/OTHER |
|
|
|
|
|
Gold |
3.3% |
-4.4% |
12.3% |
9.6% |
1.5% |
Silver |
3.9% |
-12.7% |
14.1% |
7.7% |
-1.9% |
Crude Oil |
2.6% |
58.7% |
19.2% |
7.5% |
-2.5% |
Bitcoin |
8.9% |
63.1% |
134.4% |
118.4% |
153.9% |
| Past performance does not guarantee future results. | |||||
Equity markets continued to move higher during 2021, with large cap US stocks once again leading the pack. Despite the resurgence of a milder form of Covid-19 in the fourth quarter and the Federal Reserve positioning for future rate increases, positive developments, including several effective vaccines, strong corporate earnings, and increased consumer spending, led the S&P 500 Index to a near record high. Other markets, including US small cap and international equity also ended in positive territory. Emerging markets equity was an outlier, generating a -3% return for the year, as Chinese markets were negatively impacted by the governments regulatory actions, potential default of a large, highly levered real estate developer (Evergrande) and Covid-19-driven supply chain disruptions.
During the year, a broad rush of speculative trading by amateur investors through platforms like Robinhood drove substantial, and in our minds, unwarranted gains in stocks like GameStop and AMC Entertainment Holdings, which increased 688%% and 1183% respectively. At the same time, the trend of privately held companies becoming publicly traded via Special Purpose Acquisition Companies (“SPACs”) continued apace, and the cryptocurrency market continued to soar, with bitcoin up 63%. As our clients know, we do not participate in these speculative investments, preferring instead to own high quality companies whose fundamentals are solid and growing.
The markets also had to contend with rising inflation during the year. In fact, the year ended with the Consumer Price Index (CPI) rising at its fastest rate on an annual basis since the early 1980s. To combat this inflation, the Fed has announced plans to end its monthly bond-buying program by March 2022, and policymakers have indicated plans to increase the fed funds rate at least three times in the new year. The 10-year treasury began the year at 0.91% and rose to 1.51% at year end. The fixed income markets responded as expected, with longer duration bonds, as measured by the Bloomberg U.S. Aggregate Bond Index, delivering negative returns. Our fixed income portfolios have been shorter duration than the benchmark, which added to returns in a rising interest rate environment.
Thus far in January 2022, we have seen equity markets recalibrating as investors have begun to digest the fact that inflation may not be transitory and interest rates are likely to increase. Volatility has picked up after a relatively calm 2021, and stocks with future growth potential are being punished indiscriminately without an understanding of the underlying fundamentals. As we head into 2022, it is important to reflect on our portfolios and how they are positioned going forward. In brief, we remain confident in our investment approach and our managers’ ability to generate attractive long-term returns. We are fortunate to have clients that take a long-term view and understand that compounding wealth is a multi-year process that benefits from investing in fundamentally strong companies whose value is predicated on having strong moats, growing revenues and profits, solid balance sheets, and management teams that make good capital allocation decisions. We offer the following as support for this conviction.
- We, along with our managers, are focused on value, which may not be reflected in prices over short-term time periods. As Buffet has said: “Price is what you pay. Value is what you get.” Price volatility creates opportunity to invest in businesses at discounts to intrinsic value.1 All of our managers are regularly assessing their portfolios and during the year, have taken the opportunity to add to stocks that have declined for non-fundamental reasons, and as a result have become more attractively priced, setting their portfolios up for potentially higher go-forward returns.
- We have always focused on companies that have long runways for growth, that demonstrate improving profitability and that have solid balance sheets. We believe over the long-term, the market will recognize the underlying value of these companies, but in the short-term, stock prices might not be reflective of company fundamentals. As the Fed eases up its monetary policy support, it is likely that investors will once again focus more on the fundamentals that drive stock prices—growing earnings and cash flows—which will likely bode well for active managers. In its third quarter 2021 letter, Valley Forge Capital wrote: “As investors, we must always be forward looking. Current earnings are much less important than future profits.”
- We take a long-term view with continued investment during market dislocations. Data shows that a hypothetical investment of $1 in the S&P 500 in 1990 was worth $25.86 at the end of 2021. Investors that missed the 10 best performance days would have only $11.85. Market timing simply does not work.2
- The power of compounding is remarkable but requires patience and discipline. Over a twenty-year period, buying-and-holding an investment returning 12% per year produces an after-tax3 multiple of invested capital of 7.6x (e.g., an investment of $1.0 million grows to $7.6 million). Over that same twenty-year period, selling and re-purchasing that investment five times (or every 3.33 years) produces an after-tax multiple of invested capital of 6.0x ($1.0 million grows to $6.0 million). Knowing the math behind compounding well, we prefer to be long term holders of stocks that have compelling and growing fundamentals, which is the best way to compound wealth over time.
- The greatest long-term risk to clients’ portfolios is inflation. As a result, we have done a lot of work to ensure that we are positioned appropriately to mitigate this risk. Our analysis supports the view that we have held for years – that equities – both public and private, are the best protection against inflation over the long term. Based on data back to 1980, U.S. public equities have outpaced inflation by almost 9%. Over the same time period, commodities such as gold and silver, widely considered an inflation hedge, lost money on a real, i.e., after inflation, basis. Our focus on high quality companies with strong competitive moats enables companies to raise prices without disruptions to their business, which should ultimately protect against any rise in inflation. Our managers remain confident that the companies in which they are invested can generate strong future earnings and cash flows and have solid balance sheets, enduring competitive moats and management teams that effectively allocate capital. Moreover, these companies can offset any multiple compression from rising rates by a commensurate increase in earnings growth over time, which will bode well for future returns. With respect to fixed income investments, rising rates put pressure on bond prices, especially those with longer duration. Our focus on short duration fixed income has benefited portfolios. However, gradually rising medium- and longer-term interest rates would be a welcome change for BBH, allowing us to extend the duration of clients’ fixed income portfolios to earn higher returns, including current income.
- Our managers adhere to strict valuation disciplines and are willing to hold cash rather than lowering their standards to be fully invested. We note favorably that the level of cash in our mangers’ portfolios has declined during 2021, another indication that our managers are finding compelling investment opportunities. For example, the overall cash level in the Domestic Qualified Balanced Growth Model portfolio was 2.8% at the end of 2020, and is 1.7%, at the end of 2021 which is indicative of the compelling values in our managers’ portfolios.4
Equities
All global equity benchmarks except for emerging markets generated positive returns for calendar year 2021. For the year, large cap equities (as measured by the S&P 500) generated the highest return at 28.7%. In fact, the S&P 500 notched 70 all-time highs in 2021, a record that’s second only to 1995. One of the most surprising parts of 2021 was the lack of volatility. The average maximum drawdown in a calendar year for the S&P 500 is -15.9% over the past 20 years. However, the largest drawdown of 2021 was only -5.2%. Looking at volatility another way, data on S&P 500 returns shows that there were seven days in 2021 in which the index moved more than 2%, which pales in comparison with an average of 19 days per year over the past 20 years. As we begin 2022, volatility once again has picked up, which provides greater opportunity for active managers.
Concentration in just a few names continued to persist. For example, just six tech stocks—Microsoft, Alphabet, Apple, Nvidia, Tesla and Facebook (Meta)—accounted for 33% of the S&P 500’s 2021 return. Active managers that did not own these stocks during the year faced an uphill battle to surpass the S&P 500.
Stocks that Drove S&P 500 2021 Return |
Average Weight (%) |
Contribution to Return (%) |
Total Return (%) |
|---|---|---|---|
MICROSOFT CORP |
5.72 |
2.75 |
52.48 |
ALPHABET INC-CL A |
2.05 |
1.12 |
65.30 |
ALPHABET INC-CL C |
1.97 |
1.08 |
65.17 |
APPLE INC |
6.15 |
2.07 |
34.65 |
NVIDIA CORP |
1.32 |
1.24 |
125.48 |
TESLA INC |
1.68 |
0.84 |
49.76 |
META PLATFORMS INC-CLASS A |
2.13 |
0.49 |
23.13 |
Total |
21.02 |
9.59 |
|
| Past performance does not guarantee future results. | |||
Small cap equities underperformed their large-cap peers, as measured by the Russell 2000 and S&P 500 Indices, respectively. While small cap stocks eked out a small return advantage in 2020, over a ten year period, large-cap equities have been the best performers, with the S&P 500 Index returning 16.5% versus 13.2% for the Russell 2000. One must go back 20 years to see small cap stock returns equal to their large cap peers. One might question whether or not the small-cap premium still exists. However, as our clients know, we do not invest in indices and every position in the portfolio must have the ability to generate returns that justify an allocation of our clients’ precious capital.
Outside of the U.S. returns once again disappointed on a relative basis, although they still generated respectable returns of 11.7 %. Currency hurt returns as the dollar strengthened during the year, underperforming the local return, which was up 19.4%. Following on 2020, when emerging markets equity returned 18.3%, a return that equaled that of U.S. large cap equities, several negative developments in China put pressure on these stocks, and for the year, emerging markets equity returned –2%.
Turning to sector returns, we see that there was quite a bit of dispersion during the year. The chart below shows the sector returns for the S&P 500 Index.
Past performance does not guarantee future results.
This chart shows 2021, trailing 5-year, and 2020 sector returns for the S&P 500 index.
If you are in need of the data found in this graph, please contact BBHPrivateBanking@bbh.com.
As illustrated, energy, real estate and financials were the best performers in 2021 in a stark reversal from 2020. The rationale for the capital rotation into the sectors mentioned above seems to be at least three-fold: (1) all else equal, the valuation disparity between these “pandemic recovery” sectors and the rest of the market appeared so dramatic that investors began seeking out businesses they perceived to be significantly undervalued, (2) the rollout of vaccines and reopening of the economy spurred outsized consumer demand in areas that were depressed during the pandemic allowed investors to further justify the cyclical rotation into these types of business, and (3) the threat of increasing interest rates dampened the perceived value of future cash flows for growing companies. Our portfolios are generally underweight energy, real estate and financials, particularly banks, given that our managers find it difficult to invest in cyclical companies, commodity-sensitive industries, and businesses where they can’t assess intrinsic value. While these sectors may continue to benefit in the near term, we believe that over longer periods, our clients will benefit from our approach that resists following short-term macro trends and invests in the stocks of great businesses that will be the leaders over the next five to ten years.
Reviewing the Case for Concentrated Active Management in Public Equity Markets
As many active public equity managers continued to underperform their passive indices in 2021, we thought it important to review once again our differentiated approach to active manager selection. At BBH, we typically seek to partner with privately owned boutique managers that we believe have an edge in a particular investing style and that invest their personal wealth alongside their clients. They prioritize returns over fee revenues and tend to close their strategies to new investors to ensure the size of their asset base does not dilute future returns. In addition, these public equities investors manage high‐conviction, concentrated portfolios with high active shares and spend most of their time investing and as little as possible marketing. They choose their clients carefully and aim to grow an asset base of patient, long‐term‐oriented investors. The following table shows some of the key attributes we seek.
Investment Criteria and Benefits of BBH’s Unconventional Approach to Active Management in Public Equity Markets
BBH Investment Criteria |
Why We Believe They Benefit Clients |
|---|---|
Long-term business ownership mentality |
The best way to earn long-term returns is to act like an owner of a business – knowing what one owns and why – even though his or her shares have daily liquidity. |
High-quality investing |
Businesses that produce steadily increasing cash flow and have defensible moats deliver better results to investors over time, and it is impossible to control for quality when purchasing an index. |
Insistence on a margin of safety relative to conservatively estimated intrinsic value |
Knowing the value of what they are buying, as opposed to just the price, allows investors to have “strong hands” during difficult market conditions. It is possible to add significant long-term value by maintaining or adding to positions that a manager knows well during these periods. |
Focus on outperformance over full market cycles, not “keeping up” in rising markets |
Trying to keep pace in a rising market is a recipe for taking on more risk. Doing so typically does not end well when the inevitable market downturn happens. We have seen no evidence that keeping up with the market in a range of environments is an indicator of long-term outperformance. |
Alignment of interests |
Strategies in which the managers “eat their own cooking” and have their personal wealth invested have been found to outperform strategies in which the portfolio manager does not share in the funds’ gains and losses. |
Low turnover |
By investing with a long time horizon. Low-turnover strategies are tax-efficient and allow capital gains to compound. |
High active share, concentrated portfolios |
Owning concentrated portfolios allows our managers to focus intently on a smaller set of businesses that they know extremely well as opposed to over-diversifying portfolios with low-conviction ideas. The high active share of these portfolios compared against an index allows them to achieve meaningfully differentiated results. |
With such a concentrated approach, however, the investment will occasionally endure short-term periods of underperformance in order to achieve the outperformance one expects over the long term. If we look at one of our highest conviction managers in the Domestic Non-Qualified Taxable Balanced Growth portfolio, the Akre Focus Fund, we can see that there were inevitably years in which the manager did not outperform an Index. This pattern of returns is a feature of a concentrated active approach and not a bug.
This chart shows Akre Focus Fund Annual Returns and 10-Year/Since Inception Trailing .Returns.
If you are in need of the data found in this graph, please contact BBHPrivateBanking@bbh.com.
| RETURNS THROUGH DECEMBER 31, 20215 | |||||||
|---|---|---|---|---|---|---|---|
STRATEGY/ |
3 MO. |
YTD |
1 |
3 |
5 |
10 |
Since |
AKRE FOCUS FUND SUPRA INSTITUTIONAL SHARES (AKRSX) |
7.00 |
24.62 |
24.62 |
26.83 |
23.06 |
18.94 |
19.42 |
S&P 500 INDEX |
11.03 |
28.71 |
28.71 |
26.07 |
18.47 |
16.55 |
17.16 |
Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling 1-877-862-9556.
Performance results are before the deduction of the BBH investment advisory fees. The deduction of an investment advisory fee will reduce an investor’s return. The fee schedule is described in Schedule A of the Investment Advisory Services Agreement.
“Patience is an investor’s capacity to endure periods of underperformance in hopes of achieving an investment objective. The benefits of using outperforming managers…can be significantly eroded, however, for an investor who fails to maintain a long-term patient perspective and sells during short term underperformance. This is because the inconsistency inherent in returns wears on patience. In theory, most investors are fine with drawdowns. They have been told to expect them. However, evidence shows that investors struggle when the frequency, duration, and magnitude of drawdowns mount. Those with high conviction and the appropriate risk tolerance for active risk are more likely to have the patience necessary for success in active investing, as they will be able to prepare for and tolerate the frequency, magnitude, and length of these drawdowns, and ultimately earn the long-term returns that our managers have successfully generated.”6
Fixed Income Update
2021 was an interesting year for fixed income with various fixed income markets posting wildly different returns – for example there was an 11% spread between the return of US TIPS (+6.1%) and Global Aggregate Bonds (-4.9%). Interest rates, credit spreads, and inflation expectations all moved differently across several markets.
The 10-year U.S. Treasury yield started the year below 1% and ended just above 1.5%, which brings it back to pre-covid levels. In credit, investment grade corporate credit spreads were relatively unchanged over the full year. With the increase in yields off a low base, the Bloomberg US Aggregate Bond Index lost 1.5% on a total return basis, the worst year since losing 2.0% in 2013 and only the third time in 23 years that it has lost value over a full calendar year. Non-investment grade bonds, however, finished the year with a 5.3% return as tightening credit spreads more than offset any increase in rates. Similarly, in the TIPS market, increases in inflation expectations more than offset the rise in nominal interest rates, leading to strong gains.
At BBH our fixed income allocations have been overweighted to short duration bonds for several years, as our investment team found it difficult to invest in taxable bonds and munis at a time of historically low yields. We continue to believe that being patient in fixed income, as opposed to reaching for yield, will pay off. While it is impossible to know what will happen in 2022, with inflation running high and the Fed poised to start increasing interest rates, we believe that 2022 may provide us the opportunity to add duration, and we stand ready to act if and when interest rates and or credit spreads provide this opportunity.
Looking Ahead
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.7
Some investors may be surprised to see an estimate of 6.3% in U.S. Large Caps when the S&P 500 has returned 16.5% annualized in the past 10 years. In 2032, if we are looking back at the S&P 500’s past 10 year annualized return, we would be very surprised if it got close to the 16.5% it has averaged the past 10 years. In many respects, these assumptions underscore the need for active management. While investors would have done well to own the index in the past 10 years, we believe that achieving superior absolute returns in the coming years will require strong active management.
For 2021 our 20-year capital market estimates are as follows:8
2022 Capital Market Expectations − 20-Year Time Horizon
As of December 31, 2021
Asset Class |
Pre-Tax Expectations Geometric Return (CAGR) |
|---|---|
| Fixed Income |
|
Short Duration Bond Funds |
2.4% |
U.S. Investment Grade Taxable Bonds |
3.0% |
U.S. Investment Grade Tax-Exempt Bonds |
1.7% |
Non-Investment Grade Debt |
3.7% |
Private Debt |
7.0% |
Equity |
|
U.S. Large-Cap Equity |
6.3% |
U.S. Small-Cap Equity |
7.3% |
Non-U.S. Developed Equity |
6.3% |
Emerging Markets Equity |
7.3% |
Private Equity / Distressed |
10.3% |
Real Assets |
|
Private Real Estate |
7.0% |
1 Intrinsic value is an estimate of the present value of the cash that a business can generate and distribute to shareholders over its remaining life.
2 Past performance does not guarantee future results. The hypothetical value assumes reinvestment of income and capital gains.
3 (assuming highest tax rate)
4 Portfolio holdings and characteristics are subject to change.
5 Performance shown prior to the inception of the Supra Institutional Class shares reflects the performance of the Fund’s Institutional Class shares. The performance of the Supra Institutional Class share is higher than the performance of the Institutional Class shares because Supra Institutional Class shares have lower expenses. The inception dates for the Akre Focus Fund Supra Institutional Shares and Institutional Class shares were 8/31/2015 and 8/31/2009 respectively. BBH inception was 9/1/2015.
6 Chris Tidmore and Andrew Honm, Patience with Active Performance Cyclicality: It’s Harder than You Think, The Journal of Investing, June 2021.
7 Alpha is the extra return due to non-market factors. This risk-adjusted factor takes into account both the performance of the market as a whole and the volatility of the manager.
8 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.
There is no assurance the return projections will be achieved.
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. 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.
The Akre Focus Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The summary and statutory prospectus contain this and other important information about the investment company, and it may be obtained from your investment professional. Read it carefully before investing.
The S&P 500 is an unmanaged weighted index of 500 stocks providing a broad indicator of stock price movements. The index is not available for direct investment. The composition of the index is materially different than the Fund's holdings.
“Bloomberg®” and the Bloomberg indexes are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indexes (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Brown Brothers Harriman & Co (BBH). Bloomberg is not affiliated with BBH, and Bloomberg does not approve, endorse, review, or recommend the any fund or strategy. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the fund.
Investment Advisory Products and services:
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Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2022. All rights reserved. PB-05067-2022-02-02
