2019 Annual Shareholder Letter
Dear Fellow Shareholder,
What a difference a year makes. 2019 began with investors reeling from the nearly 20% decline in global equity markets in the fourth quarter of 2018. However, following the Federal Reserve’s pivot to looser monetary policy and a break in the U.S./China trade war, markets rebounded strongly and finished the year on a high note.
Across global equity markets, U.S. large-cap stocks were once again at the top of the leader board. The S&P 500 index posted gains in every quarter and ended the year at an all-time high. The index’s 31.5% total return was its second-best year since 1997, trailing only its 33% gain in 2013. Growth stocks again trounced value stocks, with the Russell 1000 Growth Stock Index beating its Value Index counterpart by ten percentage points, extending a record 12-year trend. Smaller-cap U.S. stocks (Russell 2000 Index) rose 25.5% for the year, with small-cap growth beating small-cap value by six percentage points.
Foreign equity markets were also strong but trailed the U.S. market. Developed International stocks (MSCI EAFE Index) gained 22.0% for the year. After struggling in the third quarter, emerging-market (EM) stocks (MSCI Emerging Markets Index) shot up almost 12% in the fourth quarter and returned 18.4% for the year.
Domestic credit markets also did very well, with high-yield bonds (BofA Merrill Lynch U.S. High-Yield Cash Pay Index) gaining 14.4%. Somewhat surprisingly, core bonds also posted strong returns in what could be considered a “risk-on” market environment. On the back of three Fed rate cuts, the 10-year Treasury yield declined nearly 80 basis points and the core bond index (Bloomberg Barclays Aggregate Bond Index) returned 8.7%, its best annual return since 2002 (a year when the S&P 500 lost 22%).
Note that it wasn’t corporate profit growth that drove stocks higher in 2019. Reported earnings for the S&P 500 were flat over the first three quarters of the year, with a low single-digit percentage increase projected for the fourth quarter. Instead, roughly two-thirds or more of the S&P’s return came from a sharp expansion in valuation multiples. The index’s price-to-earnings (P/E) ratio shot up from 19x trailing GAAP1 earnings to 23x at year-end. Meanwhile, the forward P/E, based on analyst earnings expectations, ended the year above 18x, close to its highest level outside of the tech stock bubble of 1999-2000. Many other valuations metrics also suggest the U.S. market is overvalued.
For the year, the Litman Gregory Masters International Fund gained 30.45%, strongly outperforming the 21.51% return for the MSCI ACWI ex USA Index. The Litman Gregory Masters Equity Fund gained 27.55%, trailing the 31.02% for its Russell 3000 Index benchmark. The Litman Gregory Masters Smaller Companies Fund was up 23.72%, compared to 25.52% for the Russell 2000 Index. The Litman Gregory Masters Alternative Strategies Fund returned 8.52%, compared to 2.61% for 3-month LIBOR and 7.48% for the Morningstar Multialternative category. Since inception, the Masters Alternative Strategies Fund has the highest risk-adjusted return (as measured by both the Sharpe and Sortino ratios) in its Morningstar category. Finally, the Litman Gregory Masters High Income Alternatives Fund gained 8.37%, compared to an 8.72% return for the Bloomberg Barclays Aggregate Bond Index, 14.41% for the high-yield bond index and 6.20% for the HFRX Fixed Income – Credit Index.
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.
We believe the Litman Gregory Masters Funds can fill a valuable role within a diversified investment portfolio. Each of the Masters Funds is sub-advised by a group of highly disciplined, experienced, and skilled investors who we believe can outperform their benchmark over a market cycle. On our three equity funds, each manager runs a distinctive, concentrated, high-conviction stock portfolio, with the goal of materially outperforming their respective market index over the long term. Our Alternative Strategies Fund can serve as a core, lower-risk yet opportunistic holding that provides access to proven managers and strategies, differentiated sources of return, and beneficial diversification relative to traditional bond and stock investments. The High Income Alternatives Fund is intended to be a complement to traditional fixed-income allocations, seeking long-term returns that are significantly higher than core fixed-income and comparable to high-yield bonds, but with lower volatility and downside risk than high-yield due to the fund’s diversified sources of return and manager strategy flexibility.
As always, we thank you for your continued trust and confidence. Our commitment and confidence are reflected in the collective personal investments in the funds by Litman Gregory principals, employees, and the funds’ trustees of over $20 million, as of December 31, 2019.
Jeremy DeGroot, President and Portfolio Manager
Jack Chee, Portfolio Manager
Rajat Jain, Portfolio Manager
Jason Steuerwalt, Portfolio Manager