Did You Miss the Forest for the Trees?

UX-AdminEducational Series

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When you’re too close to a situation, it’s helpful to step back and get a big-picture perspective. In the investment world, that means looking well beyond how various types of investments are performing today, and instead looking for performance over the long haul.

Investors often focus too much on just one Asset Class, usually the best performing Asset Class over recent months and years. Performance, however, tends to run in cycles as various Asset Classes fall in and out of favor-which means this year’s leader may be next year’s laggard. Chasing the prior years’ hot Asset Class can be downright dangerous to your portfolio.

In the chart below, we can see how U.S. large cap stocks (S&P 500) underperformed quite a few Asset Classes between 2002 and 2012. Since 2013, however, the S&P 500 has demonstrated strong performance. Given the recent strength of the S&P 500, it’s only natural that some investors would be inclined to allocate more and more of their portfolios to it. The proliferation of ETFs has led many investors to overweight the S&P 500, with an expectation that the last several years of outperformance will continue.

Asset Class Performance

Source Hanlon Research, Morningstar

Beyond gravitating toward hot performers, investors also tend to cling to familiar markets. U.S. investors are typically guilty of over-emphasizing the S&P 500, U.K. investors typically overweight British stocks and Canadian investors tend to gravitate towards Canadian stocks. Similarly, many investors build portfolios around stocks in companies whose products they use and encounter daily. These tendencies can result in portfolios that lack the diversification that’s needed for strong performance over the long run.

Looking again at the chart, we can see that between 2002 and 2012, many Asset Classes-including international equities, emerging market equities, emerging market bonds and commodities-outperformed the S&P 500. These are Asset Classes many investors should include when constructing their portfolios: Financial markets are incredibly connected on a global level, and these Asset Classes represent a huge portion of the total investable universe.

This need for broad diversification is one reason why we created the Hanlon All-Weather Models. These multi-Asset Class, multi-strategy, dynamic portfolios give investors exposure to a variety of Asset Classes, in an optimal allocation based on expected risk, return, and correlation assumptions. When one Asset Class inevitably underperforms, other Asset Classes may counter that decline and lessen the overall impact on the portfolio.

The table on the right shows the Asset Classes used as the building blocks of the Hanlon All-Weather Models. For each Asset Class, we utilize ETFs and mutual funds that have been carefully selected to provide the best combined performance in tracking each Asset Class. (The prevalence of low-cost ETF investments reflects our determination to deliver a cost-conscious solution.)

We organize our building blocks into broader classifications that indicate the role, or investment objective, that each block supports Growth, Income, Tactical, and Alternative.

Investment Objective

Source Hanlon Research

The Asset Classes in the Growth investment objective cast a wide net across global equity markets. Our US Equity exposure seeks to track the S&P Total Market Index, which goes far beyond the S&P 500 and includes roughly 3,800 U.S.-based stocks across mega, large, mid, small, and micro-market capitalization stocks. The other two Growth Asset Classes provide exposure to developed and emerging foreign markets, respectively. Foreign markets lagged the U.S. during the past several years, but, as of this writing, have outperformed the U.S. stocks in 2017 by a good margin, rewarding investors who diversified outside the United States.

The Income objective Asset Classes are similarly diversified beyond the “core” U.S. aggregate bond exposure, represented by the Intermediate Term Bond Asset Class. The global bond markets are vastly larger than the equity markets, at an estimated $82.2 trillion worldwide. The United States comprises less than half of the global bond market. Clearly, investors who limit their bond exposure to the U.S. are missing a huge opportunity. Bank loans represent an opportunity to diversify against interest rate risk, and are often unwisely omitted from investor portfolios. Our Income objective list doesn’t include high yield bonds: This is an intentional omission, since we provide exposure to that Asset Class through our tactical Hanlon Managed Income Strategy, which seeks to capture the Asset Class’ superior yield while mitigating some of the associated volatility.

The Alternative sleeve of our All-Weather models further enhances diversification. Stocks and high quality bonds, despite being historically uncorrelated most of the time, sometimes move in tandem, leaving investors exposed to potentially high volatility in their portfolios. To ensure a truly diversified portfolio, we believe it essential to include alternative Asset Classes such as commodities, real estate and more sophisticated alternative strategies. Many of these Asset Classes have the potential to perform independently, or even inversely from traditional stocks and bonds.

Further diversification is achieved by adding tactical strategies, which often use quantitative or trend-following investment modes to systematically exploit temporary market inefficiencies. These strategies are often based on known financial market anomalies that are supported by academic and practitioner research and require a disciplined, model-based approach such as momentum. Hanlon has a long-term record of employing Tactical strategies. These often lead us move to cash in times of market downside volatility, which can help act as a ballast for a portfolio, counterbalancing the period invested & temporary volatile segments rest of a portfolio and helping to mitigate downside risks. Hanlon’s tactical strategies have typically generated their best performance in the years when most Assets Classes declined in unison, and during the subsequent recovery.

Financial markets move in cycles, and today’s market leader may inevitably become tomorrow’s laggard. Decades of financial data tells us that eventually soaring Asset Classes revert to their long-term average performance, but the timing can vary widely. By using a thoroughly researched, disciplined, asset allocation approach across a broad opportunity set of investments, investors can gain peace of mind knowing that their portfolio has been constructed and tested to “All-Weather” any market climate.


The following indices are represented by the asset classes listed in the first chart: Large Blend (S&P 500) – S&P 500 TR USD; Foreign Large Blend – MSCI EAFE NR USD; Diversified Emerging Mar-kets – MSCI EM NR USD; Emerging Market Bond – JP Morgan EMBI Global Diversified TR USD; Bank Loan – S&P/LSTA Leveraged Loan TR; High Yield Bond – Markit iBoxx Liquid High Yield TR USD; Corporate Bond – Bloomberg Barclays US Aggregate Bond TR; World Bond – Bloomberg Barclays Global Aggregate TR USD; Commodities Broad Basket – Bloomberg Commodity TR USD; Real Estate – Wilshire US REIT TR USD, Energy Limited Partnership – Alerian MLP TR USD.

The S&P 500 TR USD index is an unmanaged index US large-cap stocks. The Wilshire US REIT TR USD index measures U.S. publicly-traded real estate investment trusts. The Markit iBoxx Liquid High Yield TR USD index tracks the broad universe of US high yield corporate bonds. The S&P/LSTA Leveraged Loan TR index measures the performance of the of the leverage loan market. Bloom-berg Barclays US Aggregate Bond TR index tracks the broader US Investment-grade, fixed-rate, and taxable areas of the bond market. The Bloomberg Barclays Global Aggregate TR USD index tracks the global investment grade fixed income debt of approximately twenty-four emerging and developed markets. The Alerian MLP TR USD index measures energy Master Limited Partnerships. The Bloomberg Commodity TR USD index reflects commodity futures price movements. The JP Morgan EMBI Global Diversified TR USD index measures the market for U.S.-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities. The MSCI EAFE NR USD index tracks foreign stocks from the perspective of a North American investor. It includes a selection of stocks from 21 developed markets, but excludes the US and Canada. The MSCI EM NR USD index measures the equity market performance in global emerging markets. Indices cannot be invested in directly.

Past performance is not a guarantee of future results. This Market Commentary is limited to the dissemination of general information pertaining to its investment advisory services and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock and bond markets involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice. Hanlon has experi-enced periods of underperformance in the past and may also in the future. The returns represented herein are total return inclusive of reinvesting all interest and dividends. Hanlon Investment Manage-ment (“Hanlon”) is an SEC registered investment adviser with its principal place of business in the State of New Jersey. Hanlon and its representatives are in compliance with the current registration and notice filing requirement imposed upon registered investment advisers by those states in which Hanlon maintains clients. Hanlon may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. Any subsequent, direct communication by Hanlon with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Hanlon, please contact Hanlon or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Hanlon, including fees and services, send for our disclosure statement as set forth on Form ADV from Hanlon using the contact information herein. Please read the disclosure statement carefully before you invest or send money. Not all Hanlon clients are in the strategies discussed herein.