2018 Semi-Annual Shareholder Letter
Dear Fellow Shareholder,
As we pause to reflect at the midpoint of the year, it seems so far 2018 has served as yet another reminder to investors that over the short term, markets are driven by innumerable and often random factors that are impossible to consistently predict. In the first quarter, US stocks experienced their first major losses since 2016 and a return to more “normal” market volatility. Many market prognosticators speculated that this could indeed be the end of the nearly decade-long US bull market.
Fast-forward through three more eventful months and this time around US stocks have been the net beneficiaries, with the S&P 500 Index gaining 3.43% for the quarter, giving them a 2.65% return for the first half of the year. Small-cap stocks did even better, with the Russell 2000 Index gaining 7.75% in the second quarter and 7.66% on the year, driven by the narrative that smaller company profits are less exposed to a strengthening dollar and potential trade wars.
A sharp rebound in the US dollar beginning in April hurt foreign stock returns for dollar-based (unhedged) investors. The MSCI EAFE Index of developed international stocks fell 2.75% for the six-month period. In addition to the negative currency effects, emerging markets were buffeted by increasing trade tensions between the United States and its trading partners—China in particular—and tightening financial conditions. Emerging-market stocks declined 6.66% for the period.
In the bond markets, the benchmark 10-year Treasury yield pierced the 3% level in May, hitting a seven-year high. Yields then fell back, ending the second quarter at 2.85%, an 11-basis-point increase from the prior quarter-end. Overall, the Bloomberg Barclays US Aggregate Bond Index posted a slight loss for the quarter and is down 1.62% year to date.
For the first half of the year, the Litman Gregory Masters International Fund declined 1.52%, outperforming its primary benchmark, the MSCI ACWI ex USA Index, which was down 3.77%, and the Morningstar Foreign Large Blend category’s loss of 2.96%. The Litman Gregory Masters Equity Fund gained 2.72%, trailing the Russell 3000 Index’s 3.22% return, in line with the S&P 500 Index return, and ahead of the Morningstar Large Blend category return of 1.67%. The Litman Gregory Masters Smaller Companies Fund gained 5.36% for the year to date, lagging the Russell 2000 Index and in line with the Morningstar Small Blend category return. The Litman Gregory Masters Alternative Strategies Fund was down 0.26% for the period, compared to a 1.62% loss for the Bloomberg Barclays US Aggregate Bond Index, a 1.15% loss for the Morningstar Multialternative category, and a 0.91% gain for 3-Month LIBOR. The fund has the highest risk-adjusted return (as measured by both the Sharpe and Sortino ratios) in its Morningstar Multialternative category since inception. Please see the individual fund semi-annual reports for additional portfolio details and commentary.
Performance quoted represents past performance and 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 funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.mastersfunds.com.
Thoughts on the Bigger Picture
It is understandable that geopolitical conflicts, in general, and fears of a global trade war, in particular, are rattling financial markets. Any resolution of the current trade tensions is a meaningful uncertainty. The process is likely prone to several more twists and turns before things become any clearer, and nobody knows how it will all play out.
Our view on the matter, for what it’s worth, remains that it is in the broad best interests of the United States, China, and others to negotiate a resolution and prevent trade skirmishes from becoming an all-out trade war. However, the potential for a severely negative shorter- to medium-term shock to the global economy and risk assets can’t be dismissed. Even absent an actual trade war, the negative impact on business and consumer confidence and spending from the uncertainty is a risk to the remaining longevity and strength of the current economic cycle.
However, there are always risks and uncertainties when investing that have the potential to cause significant market volatility in stocks and other riskier assets. Whether it is a trade war, a geopolitical event, an unexpected economic shock, a monetary policy mistake, or innumerable other “known unknowns,” stocks can deliver big losses, at least over shorter-term periods. Market corrections and bear markets inevitably happen. An investor must be able to withstand these drops, stay the course, and stick to their long-term plan (assuming the plan was well-designed and aligned with their financial objectives to begin with!).
No one can consistently and accurately predict the timing, outcome, and market reactions of these types of macro/geopolitical uncertainties. A corollary, therefore, is that investors who try to do so are very likely to detract more value than they add over time. They’re more likely to get whipsawed by the daily news headlines and changing “expert” opinions amid market ups and downs. While they may feel better in the moment of their action, they end up with a worse outcome than if they had remained disciplined in their investment approach.
We believe a critical element of Litman Gregory’s investment process—both in our active manager due diligence for the Masters Funds and in managing diversified multi-asset portfolios for our investment advisory clients—is our discipline to maintain a longer-term (full market cycle) perspective, while many other market participants often over-react to short-term performance swings, daily news flow, and other emotional/behavioral triggers.
We believe it is far better to stick with one’s long-term strategic portfolio allocation (with disciplined rebalancing). Or, to only make portfolio changes away from your strategic allocation when you have high confidence (based on strong evidence and analysis) that you have an edge. This is possible if you understand what the market is discounting in current asset prices, why you think the market is wrong, and why the odds are stacked in your favor that you are likely to ultimately be proven right. Even then, of course, there is no guarantee you will be right every time. In fact, it is guaranteed you won’t be right every time. That’s why portfolio diversification and risk management can also be critical elements to successful long-term investing.
Within a diversified total portfolio, we believe the Equity and Alternative Strategies funds can play important roles. Our equity funds are sub-advised by a group of highly disciplined, experienced, focused investors. Each manager is running a distinctive, concentrated, high-conviction stock portfolio for our funds, with the objective to materially outperform their respective market indexes over the long term. We believe our Alternative Strategies Fund can serve as a core, lower-risk holding that provides access to proven managers and strategies, differentiated (alternative) sources of return, and beneficial diversification relative to a traditional stock/bond balanced portfolio.
As always, we thank you for your confidence in the Litman Gregory Masters Funds. Our commitment and confidence is reflected in the collective personal investments in the funds by Litman Gregory principals, our employees, and the funds’ trustees of over $21 million, as of June 30, 2018.
Jeremy DeGroot, President and Portfolio Manager
Jack Chee, Portfolio Manager
Rajat Jain, Portfolio Manager