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Markets in Motion - Basketball Bracketology & Behavioral Finance

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Markets in Motion - Basketball Bracketology & Behavioral Finance

It’s mid-March, which means it’s time for one of our favorite spring activities, observing classic Behavioral Finance mistakes inherent in bracketology for the NCAA basketball tournament. Here we’ll focus on mistakes commonly made when filling out your NCAA tournament bracket that are very similar to those often made when choosing/changing investment manager line-ups for portfolios.

 

  1. Picking your Alma Mater to go deep into the tournament despite obvious weaknesses. No, Idon’t always pick Duke to win it all; foul shooting and three-point percentage are major factors this year.
    Behavioral Equivalent Status Quo Bias
    Consistently maintaining large allocations to your “home” markets regardless of valuation, credit conditions, economic conditions, tail risks, etc., because that’s all you’ve ever done. Global investing in all asset classes consistently delivers solid risk-managed outcomes and smooths out the long-term ride for clients.
     
  2. Picking your Alma Mater’s rival(s) to lose in the first round despite obvious strengths. UNC &Kentucky are balanced and loaded with talent; they are “friends” in gathering bracket points.
    Behavioral Equivalent Anchoring
    Refusing to maintain a diversified portfolio because you are anchored on “bearish” or “bullish” personal view. Investors anchored on fear and the specter of global meltdown (2008) have missed huge opportunities for their clients in the last 10 years. Use managers who consider wide ranges of opinions and quantitative measures in their allocation process and are constantly assessing the risk environment for you.
     
  3. Refusing to pick a team because you have been burned by them last year. Yes, Virginia, you’re a#1 seed again, prove me right this time, at least for a couple of weeks.

    Behavioral Equivalent Availability
    Overreacting to recent and vivid information, like the brutal December many of us endured is a classic example. Investors sometimes fail to consider their Managers’ long-term track record and more crucially their role in overall diversification after a recent bout of underperformance or market volatility. Managers who have long-term success, like great college basketball programs who occasionally stumble in March, learn from difficult investing environments and continue to improve their service and performance levels.

  4. Picking a team because a TV analyst did, despite the analyst’s clear bias, e.g., Jalen Rose picking Michigan or Charles Barkley with Auburn.


    Behavioral Equivalent Halo Effect
    Making annual Manager changes because you pay attention to subscription media and advertising “Research” rankings and not your own (or your firm’s) due diligence. This leads to “Performance Chasing.”

  5. Last but not least: picking a Cinderella team past the sweet sixteen because you like one of theirplayers or maybe their mascot. Ja Morant and the Racers score on both counts.


    Behavioral Equivalent Innumeracy
    Building a great bracket is a statistical and information-laden process. Consistently betting on longshots is a very consistent road to ruin. I’m shocked every year to find out how many Investors consider speculation as an investing alternative.

The “bracket” that counts in any year for investing must be informed by the big picture, not the small ones that confuse and blind investors to the larger macro-economic trends at work. What do Buffet or Cramer think? What about that guy in the Wall Street Journal? These are the “noise” questions that take investors away from the Plan, which is “how do I achieve an annualized return that comes from a diversified portfolio constructed with risk guidelines?”

From a positioning perspective, no allocation changes were made to any of our portfolios this month. Global risk markets have been grinding higher behind dovish Central Bank guidance, and our barbell positioning of diversified very short duration bond and Global equities exposure has been working quite well. The mildly conservative positioning profile seems warranted in front of this week’s Federal Open Market Committee (FOMC) meeting, as we feel it will be quite difficult for the Fed to exceed the extremely dovish expectations currently priced into markets. The Fed’s dot plot assumes two hikes playing out this year, yet Fed Fund Futures are assigning 0% odds of a hike in 2019 and pricing in a 36% chance of a cut by next January. The question we have asked ourselves is: will the Fed continue to be friendly toward the market given the magnitude of the run higher in stocks?

Portfolio Positioning

2019-03-chart-2

2019-03-chart-3Recent Portfolio Changes

• The portfolio is maintaining its current target allocations. We remain convicted in our previous positions.

GTA Portfolio Changes
Since November 30, 20181

Cash and Cash Equivalents

We continued to increase our position to cash equivalents. After a 15%+ bounce for the S&P 500, the index is at strong resistance levels and has yet to break out of a sideways trend from 2018. It moved from “extreme” oversold conditions to overbought very quickly. High cash levels are warranted.

Fixed Income (US)

We trimmed our positions in, Preferred Stocks. We remain convicted in our positions, and all still have positive tailwinds in place, but trimming risk at overbought levels is prudent.
Avoiding long duration fixed income in our portfolios: We favor ultra-short duration at the expense of allocations to long-dated fixed income. Interest rates will continue to move higher leading to uninspiring total returns to duration.

Fixed Income (International)

We continue to maintain Emerging Market Bonds – it’s attractive yield and the current tailwinds for emerging markets will continue to provide the diversification benefits to the portfolio.

Equity (US)

We exited our position in US Small-Cap Value equities. We reduced our US equity exposure and moved into a more favorable sector.

We exited our positions in Medical Devices and Value, as well as trimmed our position in Technology and Health Care. We initiated and maintain a position in Quality factor equities. We continued to consolidate exposure in our US equity book and moved to neutral positioning vs. the benchmark. Quality equities possess pricing power, exhibit strong profitability, and have additional sustainable competitive advantages which allow businesses to remain viable over time. We feel this holding is prudent in the later stages of the US credit cycle. The pace of disruption of old industries by new products and processes has continued to accelerate, and technology gives us exposure to this process of creative destruction. Aging demographics and strong corporate balance sheets in the health care sector should provide tailwinds for the industry – its defensive nature also acts as an important asset allocation tool.

Equity (International)

We exited our position in Small-Cap Japanese equities. Japan’s monetary policy remains loose, but its earnings outlook is murkier. Our Japanese equity stance is now neutral.

We added to our position in Emerging Market equities and continue to maintain it. The most important risk to emerging markets—a big Chinese growth slowdown or collapse in its currency—is unlikely. We are still watching the effects the trade war with China could have on Asia, but tensions are easing and our overall outlook is more positive. We believe that these risks are now mainly contained, and despite a strong rebound year-to-date, China’s equity markets still have plenty of headroom. This has been bolstered by evidence of China scaling back their deleveraging campaign – January credit growth data exploded. We are now overweight emerging market equities.

We exited our position in Global Consumer Staples and initiated a position in Developed Market Equities (ex-US). We removed a sector tilt and added exposure to our International equity allocations. Our portfolio remains underweight Eurozone equities.

Alternatives

We exited our position in Mortgage REITs. We trimmed but maintain a position in Energy MLPs. We are concentrating our alternative exposure around our convicted view in Energy MLPs. The oil rout that began in October appears to have run its course. Oil seems to have found a bottom, and at this point, a regime failure in Venezuela is a high probability event which poses immediate risks to global oil production – a positive for WTI & Brent prices and a tailwind for energy infrastructure.


If you are a financial advisor and want to see the full version, request access to our Advisor Resources section.

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Please do not hesitate to contact us with any questions!
Best regards,

John A. Forlines III

Chief Investment Officer

Robert Shea

Co-Chief Investment Officer


1Information as of 3/11/2019. Individual account allocations may differ slightly from model allocations.
2Some Emerging Markets allocation overlaps with regional allocations.
3Excludes GTA’s alternative, cash, and cash equivalent positions.
4Contains international exposure

Past performance is no guarantee of future results. The material contained herein as well as any attachments is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies, opportunities and, on occasion, summary reviews on various portfolio performances. Returns can vary dramatically in separately managed accounts as such factors as point of entry, style range and varying execution costs at different broker/dealers can play a role. The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Forecasts are inherently limited and should not be relied upon as an indicator of future results. There is no guarantee that these investment strategies will work under all market conditions, and each advisor should evaluate their ability to invest client funds for the long-term, especially during periods of downturn in the market. Some products/services may not be offered at certain broker/dealer firms.

The investment descriptions and other information contained in this Markets in Motion are based on data calculated by W.E. Donoghue & Co., LLC (W.E. Donoghue) and other sources including Morningstar Direct. This summary does not constitute an offer to sell or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities. This report should be read in conjunction with W.E. Donoghue’s Form ADV Part 2A and Client Service Agreement, all of which should be requested and carefully reviewed prior to investing.

The Global Tactical Allocation Composite (“Composite”) was created on July 1, 2009. The Global Tactical Conservative Composite (“Composite”) was created on February 1, 2014. The Global Tactical Income Composite (“Composite”) was created on February 1, 2014. The Global Tactical Growth Composite (“Composite”) was created on February 1, 2015. W.E. Donoghue acquired 100% of the assets of JFG on December 29, 2017.

Composite returns are calculated gross of investment management fees, net of investment trading expenses and underlying fund costs but do not reflect the effect of income taxes on the investment returns. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. Performance reflects the reinvestment of dividends, income, and capital appreciation. Composite returns are calculated monthly, which are described in greater detail in the firm’s Form ADV Part 2A, using the time-weighted total rate of return methodology. Monthly returns are geometrically linked to calculate quarterly and annual returns. As fees are deducted quarterly, the compounding effect will be to increase or decrease their impact by an amount directly related to gross portfolio performance, and dependent on direction, magnitude, and order of returns. For example, on a portfolio with a 2% annual fee, if gross performance is 10%, and performance is equally distributed across all four quarters, the compounding effect of the fees will result in a net annual performance of 7.81%. No leverage, derivatives, or shorts are used. Past performance is not indicative of future results.

There can be no assurance that the purchase of the securities in this portfolio will be profitable, either individually or in the aggregate, or that such purchases will be more profitable than alternative investments. Investment in any Global Tactical Portfolio, or any other investment or investment strategy involves risk, including the loss of principal; and there is no guarantee that investment in W.E. Donoghue’s Portfolios or any other investment strategy will be profitable for a client’s or prospective client’s portfolio. Investments in W.E. Donoghue’s Portfolios, or any other investment or investment strategy, are not deposits of a bank, savings, and loan or credit union; are not issued by, guaranteed by, or obligations of a bank, savings, and loan, or credit union; and are not insured or guaranteed by the FDIC, SIPC, NCUSIF or any other agency. The composite strategy provides diversified exposure to various asset classes such as equities, fixed income, and alternatives utilizing liquid exchange-traded products. Diversification does not guarantee a profit or protect against a loss.

The Blended Benchmark Growth is a benchmark comprised of 65% MSCI ACWI, 25% FTSE World Government Bond Index, and 10% S&P GSCI, rebalanced monthly. The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The FTSE Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The Blended Benchmark Growth returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly in an index. A more detailed description of the benchmark's constituents is available upon request.

The Blended Benchmark Moderate is a benchmark comprised of 50% MSCI ACWI, 40% FTSE World Government Bond Index, and 10% S&P GSCI, rebalanced monthly. The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The FTSE Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The Blended Benchmark Moderate returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly in an index. A more detailed description of the benchmark’s constituents is available upon request.

The Blended Benchmark Conservative is a benchmark comprised of 35% MSCI ACWI, 55% FTSE World Government Bond Index, and 10% S&P GSCI, rebalanced monthly. The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The FTSE Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The Blended Benchmark Moderate returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly in an index. A more detailed description of the benchmark’s constituents is available upon request.

The Blended Benchmark Income is a benchmark comprised of 90% Bloomberg Barclays Global Aggregate Bond Index, and 10% MSCI ACWI, rebalanced monthly. The Bloomberg Barclays Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. There are four regional aggregate benchmarks that largely comprise the Global Aggregate Index: the US Aggregate (USD300mn), the Pan-European Aggregate, the Asian-Pacific Aggregate, and the Canadian Aggregate Indices. The Global Aggregate Index also includes Eurodollar, Euro-Yen, and 144A Index-eligible securities, and debt from five local currency markets not tracked by the regional aggregate benchmarks (CLP, MXN, ZAR, ILS and TRY). A component of the Multiverse Index, the Global Aggregate Index was created in 2000, with index history backfilled to January 1, 1990. The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The Blended Benchmark Income returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly in an index. A more detailed description of the benchmark's constituents is available upon request.
The information contained in this presentation related to JAForlines represents the strategies and performance achieved prior to the acquisition.

W.E. Donoghue & Co., LLC is a registered investment advisor with the United States Securities and Exchange Commission in accordance with the Investment Advisors Act of 1940.

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JAForlines has been acquired by and operates through W.E. Donoghue & Co., LLC.
W.E. Donoghue is a registered investment adviser with United States Securities and Exchange Commission in accordance with the Investment Advisers Act of 1940.

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