Market & Performance Update: Quarterly - SEI
Quarterly Market Commentary Second Quarter 2015
The second quarter was notable for its subdued activity, as central banks mostly held course. Fixed-income market performance was mostly negative; currency effects played a secondary role to other forces. Equities were generally positive, although late-quarter volatility had a negative impact that offset a majority of gains.
Economic Backdrop If the first quarter was punctuated by a flurry of central-bank actions, the second quarter was notable for its subdued activity as central banks ― major and otherwise ― mostly held course. The U.S. Federal Open Market Committee (FOMC) deferred a rate increase during its June meeting in the wake of unimpressive economic data, focusing expectations on September and downplaying the impact of its first eventual rate hike. The Bank of England’s (BOE) Monetary Policy Committee announced no change to its record-low Bank Rate and indicated in May’s meeting minutes that a 2015 rate hike would be unlikely; although a continued firming of earnings growth could alter the outlook. The European Central Bank (ECB) reaffirmed a commitment to fulfilling its asset-purchase program, and lobbied for fiscal reform to carry a greater responsibility in fostering economic growth. Aid to Greece ― both in the form of emergency loan assistance and pending negotiations as a creditor ― has occupied a great deal of the ECB’s attention in recent months. Finally, the Bank of Japan held rates near zero and continued its asset-purchase program. Inflation remained elusive, but first-quarter economic growth was promising. The U.S. employment landscape continued to make headway, with initial jobless claims’ four-week moving average declining at the beginning of April for the third consecutive week — reaching the lowest point since June 2000 — and remaining around this level through the end of the quarter. The unemployment rate fell to 5.3% in June, the lowest point in seven years. Consumer spending in May had the biggest monthly increase in six years, as personal incomes jumped 0.5%. Manufacturing ended the quarter decelerating by slightly more than expected, driven by a third consecutive monthly drop in exports and reduced capital investment in the energy sector; however, new orders and hiring improved. Services sector growth, meanwhile, continued to expand despite losing some momentum in May. Consumer and producer prices both posted record highs in May, largely due to a jump in gasoline prices. New home sales gained in April and May, reaching a seven-year peak in the latter month. While the U.S. economy contracted by 0.2% in the first quarter, it was by less than forecasted. U.K. manufacturing activity began the quarter significantly decelerating in April after reaching an eight-month high in the previous month; the sector ticked slightly higher in May only to finish the quarter with the weakest monthly growth reading in over two years. Retail sales had a strong quarter overall, with the sixth consecutive month of year-over-year growth in May; sales in June remained above average for season despite easing slightly for the month. Most retail sales growth for the quarter was driven by food and gasoline, while clothing sales declined. Average house prices unexpectedly gained momentum in April, but retreated in both May and June — reaching the slowest annual growth rate in two years. The labor market improved in the quarter on a persistently declining claimant count and record wage increases; the unemployment rate fell to and remained at 5.5%, while wages rose to 2.7% (the fastest rate since 2011). The U.K. economy expanded by 0.3% in the first quarter — the slowest pace of expansion since 2013 — mainly on decreased activity within mining, quarrying and construction. Year-over-year growth also slowed. Eurozone manufacturing growth unexpectedly slowed in April, but rebounded in May and hit a 14-month high in June. The services sector struggled overall during the quarter, contracting for two out of the three months. Consumer confidence weakened in April and May yet was unchanged in June. Consumer prices stopped falling during April, breaking a declining trend, and rose in May for the first time in six months; the year-over-year rate of growth slowed in June. Producer prices declined for the first two months of the quarter, primarily due to weakness in energy costs. The labor market made progress in April, as the unemployment rate edged down to 11.1% — the best reading since mid-2013 — and remained steady through the rest of the quarter. Retail sales also improved in April, accelerating in both the onemonth and year-over-year periods. Eurozone economic growth in the first quarter was 0.4%, in line with the previous quarter; sluggish trade growth was offset by increased government spending.
© 2015 SEI
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Market Impact Fixed-income market performance was predominantly negative during the second quarter, with currency considerations playing a secondary role. U.S. asset-backed securities were a rare bright spot, delivering a slightly positive performance. U.S. high-yield bonds and Treasury Inflation-Protected Securities were only marginally negative, trailed closely by U.S. dollar-denominated (external) emerging-market debt; local-currency-denominated emerging-market debt fared worse. U.S. mortgage-backed securities produced middling losses relative to other fixed-income sectors, followed by global nongovernment debt and global-sovereign debt; U.S. dollar-hedged global fixed-income securities underperformed their localcurrency-denominated counterparts. U.S. Treasurys performed poorly, while U.S. investment-grade corporate debt had the deepest losses. Global equity markets were positive during the quarter (as represented by the MSCI AC World Index), although negative performance during June offset a majority of the quarter’s gains. Intra-regional performance was mostly mixed, except for the Southeast Asia-South Pacific corridor, which had the four worst country-level returns (Indonesia, followed by New Zealand, Malaysia and Australia). Egypt, Germany and the Philippines were the next three poorest performers. Hungary had the highest gains, followed closely by the United Arab Emirates. Ireland, Russia and Brazil rounded out the top five; while China, Hong Kong and Greece followed closely thereafter despite recent heightened volatility. From a global-sector perspective, telecommunications delivered the best performance by a large margin, followed by financials and healthcare. Consumer discretionary was also positive. Utilities was the worst performing sector, followed at a distance by industrials and information technology. Consumer staples and materials were also negative, while energy was only slightly so. Index Data for Second Quarter
The Dow Jones Industrial Average Index returned -0.29%. The S&P 500 Index gained 0.28%. The NASDAQ Composite Index returned 2.03%. The MSCI AC World Index (Net), used to gauge global equity performance, increased by 0.35%. The Barclays Global Aggregate Index, which represents global bond markets, fell by 1.18%. The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, increased in the quarter as a whole, moving from 15.29 to 18.23 with a sharp jump at the end of the quarter. WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $47.60 a barrel at the end of March to $59.47 on the last day in June. The U.S. dollar weakened against the euro and sterling, but strengthened against yen. The U.S. dollar ended June at $1.11 against the euro, $1.57 versus sterling and at 122.4 yen.
Portfolio Review The U.S. equity market rose modestly for larger companies during the quarter and was generally flat for smaller ones. Less-cyclically-sensitive sectors outpaced both their more defensive and cyclically-sensitive counterparts. Growth stocks continued to lead value in the quarter and over the trailing year. Sector allocation was positive, led within large caps by an overweight to healthcare, and within small-caps by an overweight to information technology and underweights to utilities and materials. Stock selection was also favorable, particularly within large-cap healthcare and financials and small-cap technology, materials and industrials. Internationally, stock selection was positive in all regions, led by the U.K. and supported by Europe, Japan and the broader Pacific region. From a sector perspective, selection within financials, consumer staples and industrials was strong, overcompensating for weak selection in information technology. Emergingmarket equities also performed well, with Asian positions (China, India, Korea) providing the greatest contributions. Russia’s continued recovery was a positive influence on its neighbors (Czech Republic, Hungary), while Latin America was pressured by struggling Brazil. At the sector level, strong selection within information technology, consumer sectors, industrials and healthcare, was partially offset by financials and telecommunications.
© 2015 SEI
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The U.S. Treasury yield curve steepened as yields rose during the quarter, pressuring our yield-curve flattening bias but contributing via our modest short-duration positioning. Sector selection within corporates (an overweight to financials and underweights to utilities and industrials) was positive. Underweights to global government and agency bonds detracted. A continued overweight to non-agency mortgage-backed securities (MBS) remained favorable, while an underweight to agency MBS and overweight to commercial MBS came under pressure. An overweight to asset-backed securities, meanwhile, was additive. The high-yield market was marginally negative on the quarter, so a defensive posture aided relative performance. An overweight to and selection within leisure, combined with underweights to telecommunications and (along with selection within) basic materials, as well as an allocation to structured credit, were beneficial. An overweight to and selection within media, in conjunction with underweights to financial services and (along with selection within) energy, detracted. Within emerging markets, overweights to Venezuelan and Kazakh quasi-sovereign external debt contributed, but were offset by an underweight to Ukrainian sovereigns and overweight to Mexican sovereigns. Local-currency positions detracted, as underlying bonds performed well but came under currency pressure. Long exposure to Turkish lira and short exposure to Brazilian real were both negative. Exposure to off-benchmark corporate debt contributed the most to outperformance, namely within Brazil, Russia and Colombia. Manager Positioning and Opportunities We continue to believe that U.S. large-cap equities are in the middle of a modest expansion, while small- and mid-caps are likely further along in the market cycle. Earnings growth has firmed over the past quarter and, while revisions within energy stocks are still negative (though less so), the consumer is showing signs of renewed strength due to lower gas prices. Small caps have outperformed large caps in the year to date, primarily due to a faster rate of earnings growth. Looking ahead, small caps are more sensitive to changes in monetary policy given their higher reliance on short-term bank financing. Our longer-term positioning favors momentum over value, as the market is no longer cheap; however, our tactical positioning has favored value as momentum grew expensive over the quarter. Overseas, we remain underweight the U.K., Europe and Japan, barring stock-specific opportunities in the former’s industrial sector. Managers remain skeptical of Japan, but we are beginning to see a warming of that view. Off-benchmark opportunities in Canada appear to show promise as well. In emerging markets, managers are emphasizing smaller consumer discretionary and health care stocks that will benefit from their growing middle classes, as well as specific industrial stocks that stand to benefit from regulation-driven infrastructure issues. The Fund remains underweight financials, but as the largest emerging-market sector it still represents our largest sector exposure. Investment-grade fixed income maintained a yield-curve flattening bias and moderate short-duration posture, although duration has been extended given the subdued outlook for global growth. Credit spreads widened modestly during the quarter; with current spread levels reflecting fair value, security selection is expected to play a larger role in performance. Further, active management opportunities should increase if volatility remains high. We remain committed to non-agency MBS on positive demand and limited issuance coupled with relatively attractive risk-adjusted yields. Agency mortgage valuations are comparatively less promising. Within corporates, an overweight to financials and underweight to industrials remain. In high yield, a defensive stance remains via allocations to bank loans and cash, especially given the former’s attractive valuations relative to BB rated bonds. Managers also intend to be selective in new purchases given recent volatility, and continue to seek out securities that are upgrade or acquisition candidates in pursuit of outsized returns. In emerging markets, we remain underweight external and local debt in favor of an allocation to corporate debt, which trades at spreads similar to external sovereign debt, but with a more appealing geographical profile (heavier weighting to Asia and lighter weightings to Latin American and Europe). Moreover, corporate positions are concentrated in high yield-rated companies that offer more attractive potential return opportunities with lower interest-rate sensitivity. Local bond exposures are concentrated in countries that offer relatively high yields. The greatest currency overweights are in countries that stand to benefit from the decline in commodity prices (Indonesia, India), or are tied to the U.S. economic recovery (Mexico).
© 2015 SEI
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Our View Investors were caught up in a whirlwind this quarter, which included both volatility and surprising countertrend movements —ranging from German bunds to Chinese equities, currencies to the price of oil. The 10-year benchmark German bund yield has surged since mid-April, dragging yields elsewhere higher in its wake (yields move inversely to prices). The ferocity of the rise highlights how quickly supposedly deep markets can turn illiquid, even in the absence of severe economic stress. The relative resiliency of eurozone equities in the face of the bond-market decline has a simple explanation: the regional economy is starting to improve, albeit in a slow and halting fashion. Eurozone exports within the currency zone have climbed more than exports outside the currency zone — a sign that internal demand is picking up. Greece remains the biggest headwind that could blow the European recovery off course. In the U.K., the stunning victory of the Conservative Party in the May general election makes it a certainty that a referendum on the country’s European Union membership will be held within the next 30 months. Opinion polls suggest that a majority of U.K. citizens favor maintaining the status quo, but nothing should be ruled out. We think recent data may be overstating the extent of U.S. weakness. First, both employment and average weekly earnings are on the rise. Second, net worth has increased — thanks to the recovery in home values and the bull market in financial assets. Third, households now are in a position to take on more debt. In a mild-to-moderate growth scenario, U.S. corporate profits and cash flow should grind their way higher. Companies are finding ways to overcome the headwinds of a sluggish economy and weak top-line growth. This ability to manage costs during a challenging quarter far exceeded expectations at the start of the latest earnings reporting season. Market reaction to the U.S. Federal Reserve’s June policy statement was a bit counterintuitive. Despite the FOMC maintaining that the first interest-rate hike could come in September, equity prices pushed higher, bond yields fell and the dollar weakened to five-month lows. The large divergence between what the FOMC is projecting and what futures traders are expecting suggests that financial markets are vulnerable to a significant rise in volatility. Our equity investment managers generally remain pro-cyclical; momentum appears expensive in the U.S, but competitively valued overseas. Larger Asian economies look favorable, while energy-sector reverberations continue to be responsible for many global pressures and opportunities. Managers in emerging markets will need to continue seeking out country-, sector- and company-specific opportunities, as opposed to riding a general wave of prosperity and growth. Fixed-income managers have noted liquidity concerns that are largely unrealized. Overall, duration is modestly short among our fixed-income managers, and the U.S dollar’s ascent is expected to continue.
© 2015 SEI
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Benchmark Descriptions The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 bluechip New York Stock Exchange stocks that are selected by editors of The Wall Street Journal. The S&P 500 Index is a capitalization-weighted index made up of 500 widely held U.S. large-cap companies. The NASDAQ Composite Index is a market value-weighted index of all common stocks listed on the National Association of Securities Dealers Automated Quotations (NASDAQ) system. The MSCI All Country World Index is a market capitalization-weighted index composed of over 2,000 companies, representing the market structure of 48 developed and emerging-market countries in North and South America, Europe, Africa and the Pacific Rim. The Index is calculated with net dividends reinvested in U.S. dollars. The Barclays Global Aggregate Bond Index is a market capitalization-weighted benchmark, tracks the performance of investment-grade fixed- income securities denominated in 13 currencies. The Index reflects reinvestment of all distributions and changes in market prices. The Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 Index over the next 30 days. A higher number indicates greater volatility. The BofA Merrill Lynch US High Yield Constrained Index measures the performance of a representative basket of high-yield bonds.
Disclosures This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There is no assurance as of the date of this material that the securities mentioned remain in or out of SEI Funds. There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results. Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI). Neither SEI nor its subsidiaries are affiliated with your financial advisor. © 2015 SEI
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The second quarter was notable for its subdued activity, as central banks mostly held course. Fixed-income market performance was mostly negative; currency effects played a secondary role to other forces. Equities were generally positive, although late-quarter volatility had a negative impact that offset a majority of gains.
Economic Backdrop If the first quarter was punctuated by a flurry of central-bank actions, the second quarter was notable for its subdued activity as central banks ― major and otherwise ― mostly held course. The U.S. Federal Open Market Committee (FOMC) deferred a rate increase during its June meeting in the wake of unimpressive economic data, focusing expectations on September and downplaying the impact of its first eventual rate hike. The Bank of England’s (BOE) Monetary Policy Committee announced no change to its record-low Bank Rate and indicated in May’s meeting minutes that a 2015 rate hike would be unlikely; although a continued firming of earnings growth could alter the outlook. The European Central Bank (ECB) reaffirmed a commitment to fulfilling its asset-purchase program, and lobbied for fiscal reform to carry a greater responsibility in fostering economic growth. Aid to Greece ― both in the form of emergency loan assistance and pending negotiations as a creditor ― has occupied a great deal of the ECB’s attention in recent months. Finally, the Bank of Japan held rates near zero and continued its asset-purchase program. Inflation remained elusive, but first-quarter economic growth was promising. The U.S. employment landscape continued to make headway, with initial jobless claims’ four-week moving average declining at the beginning of April for the third consecutive week — reaching the lowest point since June 2000 — and remaining around this level through the end of the quarter. The unemployment rate fell to 5.3% in June, the lowest point in seven years. Consumer spending in May had the biggest monthly increase in six years, as personal incomes jumped 0.5%. Manufacturing ended the quarter decelerating by slightly more than expected, driven by a third consecutive monthly drop in exports and reduced capital investment in the energy sector; however, new orders and hiring improved. Services sector growth, meanwhile, continued to expand despite losing some momentum in May. Consumer and producer prices both posted record highs in May, largely due to a jump in gasoline prices. New home sales gained in April and May, reaching a seven-year peak in the latter month. While the U.S. economy contracted by 0.2% in the first quarter, it was by less than forecasted. U.K. manufacturing activity began the quarter significantly decelerating in April after reaching an eight-month high in the previous month; the sector ticked slightly higher in May only to finish the quarter with the weakest monthly growth reading in over two years. Retail sales had a strong quarter overall, with the sixth consecutive month of year-over-year growth in May; sales in June remained above average for season despite easing slightly for the month. Most retail sales growth for the quarter was driven by food and gasoline, while clothing sales declined. Average house prices unexpectedly gained momentum in April, but retreated in both May and June — reaching the slowest annual growth rate in two years. The labor market improved in the quarter on a persistently declining claimant count and record wage increases; the unemployment rate fell to and remained at 5.5%, while wages rose to 2.7% (the fastest rate since 2011). The U.K. economy expanded by 0.3% in the first quarter — the slowest pace of expansion since 2013 — mainly on decreased activity within mining, quarrying and construction. Year-over-year growth also slowed. Eurozone manufacturing growth unexpectedly slowed in April, but rebounded in May and hit a 14-month high in June. The services sector struggled overall during the quarter, contracting for two out of the three months. Consumer confidence weakened in April and May yet was unchanged in June. Consumer prices stopped falling during April, breaking a declining trend, and rose in May for the first time in six months; the year-over-year rate of growth slowed in June. Producer prices declined for the first two months of the quarter, primarily due to weakness in energy costs. The labor market made progress in April, as the unemployment rate edged down to 11.1% — the best reading since mid-2013 — and remained steady through the rest of the quarter. Retail sales also improved in April, accelerating in both the onemonth and year-over-year periods. Eurozone economic growth in the first quarter was 0.4%, in line with the previous quarter; sluggish trade growth was offset by increased government spending.
© 2015 SEI
1
Market Impact Fixed-income market performance was predominantly negative during the second quarter, with currency considerations playing a secondary role. U.S. asset-backed securities were a rare bright spot, delivering a slightly positive performance. U.S. high-yield bonds and Treasury Inflation-Protected Securities were only marginally negative, trailed closely by U.S. dollar-denominated (external) emerging-market debt; local-currency-denominated emerging-market debt fared worse. U.S. mortgage-backed securities produced middling losses relative to other fixed-income sectors, followed by global nongovernment debt and global-sovereign debt; U.S. dollar-hedged global fixed-income securities underperformed their localcurrency-denominated counterparts. U.S. Treasurys performed poorly, while U.S. investment-grade corporate debt had the deepest losses. Global equity markets were positive during the quarter (as represented by the MSCI AC World Index), although negative performance during June offset a majority of the quarter’s gains. Intra-regional performance was mostly mixed, except for the Southeast Asia-South Pacific corridor, which had the four worst country-level returns (Indonesia, followed by New Zealand, Malaysia and Australia). Egypt, Germany and the Philippines were the next three poorest performers. Hungary had the highest gains, followed closely by the United Arab Emirates. Ireland, Russia and Brazil rounded out the top five; while China, Hong Kong and Greece followed closely thereafter despite recent heightened volatility. From a global-sector perspective, telecommunications delivered the best performance by a large margin, followed by financials and healthcare. Consumer discretionary was also positive. Utilities was the worst performing sector, followed at a distance by industrials and information technology. Consumer staples and materials were also negative, while energy was only slightly so. Index Data for Second Quarter
The Dow Jones Industrial Average Index returned -0.29%. The S&P 500 Index gained 0.28%. The NASDAQ Composite Index returned 2.03%. The MSCI AC World Index (Net), used to gauge global equity performance, increased by 0.35%. The Barclays Global Aggregate Index, which represents global bond markets, fell by 1.18%. The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, increased in the quarter as a whole, moving from 15.29 to 18.23 with a sharp jump at the end of the quarter. WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $47.60 a barrel at the end of March to $59.47 on the last day in June. The U.S. dollar weakened against the euro and sterling, but strengthened against yen. The U.S. dollar ended June at $1.11 against the euro, $1.57 versus sterling and at 122.4 yen.
Portfolio Review The U.S. equity market rose modestly for larger companies during the quarter and was generally flat for smaller ones. Less-cyclically-sensitive sectors outpaced both their more defensive and cyclically-sensitive counterparts. Growth stocks continued to lead value in the quarter and over the trailing year. Sector allocation was positive, led within large caps by an overweight to healthcare, and within small-caps by an overweight to information technology and underweights to utilities and materials. Stock selection was also favorable, particularly within large-cap healthcare and financials and small-cap technology, materials and industrials. Internationally, stock selection was positive in all regions, led by the U.K. and supported by Europe, Japan and the broader Pacific region. From a sector perspective, selection within financials, consumer staples and industrials was strong, overcompensating for weak selection in information technology. Emergingmarket equities also performed well, with Asian positions (China, India, Korea) providing the greatest contributions. Russia’s continued recovery was a positive influence on its neighbors (Czech Republic, Hungary), while Latin America was pressured by struggling Brazil. At the sector level, strong selection within information technology, consumer sectors, industrials and healthcare, was partially offset by financials and telecommunications.
© 2015 SEI
2
The U.S. Treasury yield curve steepened as yields rose during the quarter, pressuring our yield-curve flattening bias but contributing via our modest short-duration positioning. Sector selection within corporates (an overweight to financials and underweights to utilities and industrials) was positive. Underweights to global government and agency bonds detracted. A continued overweight to non-agency mortgage-backed securities (MBS) remained favorable, while an underweight to agency MBS and overweight to commercial MBS came under pressure. An overweight to asset-backed securities, meanwhile, was additive. The high-yield market was marginally negative on the quarter, so a defensive posture aided relative performance. An overweight to and selection within leisure, combined with underweights to telecommunications and (along with selection within) basic materials, as well as an allocation to structured credit, were beneficial. An overweight to and selection within media, in conjunction with underweights to financial services and (along with selection within) energy, detracted. Within emerging markets, overweights to Venezuelan and Kazakh quasi-sovereign external debt contributed, but were offset by an underweight to Ukrainian sovereigns and overweight to Mexican sovereigns. Local-currency positions detracted, as underlying bonds performed well but came under currency pressure. Long exposure to Turkish lira and short exposure to Brazilian real were both negative. Exposure to off-benchmark corporate debt contributed the most to outperformance, namely within Brazil, Russia and Colombia. Manager Positioning and Opportunities We continue to believe that U.S. large-cap equities are in the middle of a modest expansion, while small- and mid-caps are likely further along in the market cycle. Earnings growth has firmed over the past quarter and, while revisions within energy stocks are still negative (though less so), the consumer is showing signs of renewed strength due to lower gas prices. Small caps have outperformed large caps in the year to date, primarily due to a faster rate of earnings growth. Looking ahead, small caps are more sensitive to changes in monetary policy given their higher reliance on short-term bank financing. Our longer-term positioning favors momentum over value, as the market is no longer cheap; however, our tactical positioning has favored value as momentum grew expensive over the quarter. Overseas, we remain underweight the U.K., Europe and Japan, barring stock-specific opportunities in the former’s industrial sector. Managers remain skeptical of Japan, but we are beginning to see a warming of that view. Off-benchmark opportunities in Canada appear to show promise as well. In emerging markets, managers are emphasizing smaller consumer discretionary and health care stocks that will benefit from their growing middle classes, as well as specific industrial stocks that stand to benefit from regulation-driven infrastructure issues. The Fund remains underweight financials, but as the largest emerging-market sector it still represents our largest sector exposure. Investment-grade fixed income maintained a yield-curve flattening bias and moderate short-duration posture, although duration has been extended given the subdued outlook for global growth. Credit spreads widened modestly during the quarter; with current spread levels reflecting fair value, security selection is expected to play a larger role in performance. Further, active management opportunities should increase if volatility remains high. We remain committed to non-agency MBS on positive demand and limited issuance coupled with relatively attractive risk-adjusted yields. Agency mortgage valuations are comparatively less promising. Within corporates, an overweight to financials and underweight to industrials remain. In high yield, a defensive stance remains via allocations to bank loans and cash, especially given the former’s attractive valuations relative to BB rated bonds. Managers also intend to be selective in new purchases given recent volatility, and continue to seek out securities that are upgrade or acquisition candidates in pursuit of outsized returns. In emerging markets, we remain underweight external and local debt in favor of an allocation to corporate debt, which trades at spreads similar to external sovereign debt, but with a more appealing geographical profile (heavier weighting to Asia and lighter weightings to Latin American and Europe). Moreover, corporate positions are concentrated in high yield-rated companies that offer more attractive potential return opportunities with lower interest-rate sensitivity. Local bond exposures are concentrated in countries that offer relatively high yields. The greatest currency overweights are in countries that stand to benefit from the decline in commodity prices (Indonesia, India), or are tied to the U.S. economic recovery (Mexico).
© 2015 SEI
3
Our View Investors were caught up in a whirlwind this quarter, which included both volatility and surprising countertrend movements —ranging from German bunds to Chinese equities, currencies to the price of oil. The 10-year benchmark German bund yield has surged since mid-April, dragging yields elsewhere higher in its wake (yields move inversely to prices). The ferocity of the rise highlights how quickly supposedly deep markets can turn illiquid, even in the absence of severe economic stress. The relative resiliency of eurozone equities in the face of the bond-market decline has a simple explanation: the regional economy is starting to improve, albeit in a slow and halting fashion. Eurozone exports within the currency zone have climbed more than exports outside the currency zone — a sign that internal demand is picking up. Greece remains the biggest headwind that could blow the European recovery off course. In the U.K., the stunning victory of the Conservative Party in the May general election makes it a certainty that a referendum on the country’s European Union membership will be held within the next 30 months. Opinion polls suggest that a majority of U.K. citizens favor maintaining the status quo, but nothing should be ruled out. We think recent data may be overstating the extent of U.S. weakness. First, both employment and average weekly earnings are on the rise. Second, net worth has increased — thanks to the recovery in home values and the bull market in financial assets. Third, households now are in a position to take on more debt. In a mild-to-moderate growth scenario, U.S. corporate profits and cash flow should grind their way higher. Companies are finding ways to overcome the headwinds of a sluggish economy and weak top-line growth. This ability to manage costs during a challenging quarter far exceeded expectations at the start of the latest earnings reporting season. Market reaction to the U.S. Federal Reserve’s June policy statement was a bit counterintuitive. Despite the FOMC maintaining that the first interest-rate hike could come in September, equity prices pushed higher, bond yields fell and the dollar weakened to five-month lows. The large divergence between what the FOMC is projecting and what futures traders are expecting suggests that financial markets are vulnerable to a significant rise in volatility. Our equity investment managers generally remain pro-cyclical; momentum appears expensive in the U.S, but competitively valued overseas. Larger Asian economies look favorable, while energy-sector reverberations continue to be responsible for many global pressures and opportunities. Managers in emerging markets will need to continue seeking out country-, sector- and company-specific opportunities, as opposed to riding a general wave of prosperity and growth. Fixed-income managers have noted liquidity concerns that are largely unrealized. Overall, duration is modestly short among our fixed-income managers, and the U.S dollar’s ascent is expected to continue.
© 2015 SEI
4
Benchmark Descriptions The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 bluechip New York Stock Exchange stocks that are selected by editors of The Wall Street Journal. The S&P 500 Index is a capitalization-weighted index made up of 500 widely held U.S. large-cap companies. The NASDAQ Composite Index is a market value-weighted index of all common stocks listed on the National Association of Securities Dealers Automated Quotations (NASDAQ) system. The MSCI All Country World Index is a market capitalization-weighted index composed of over 2,000 companies, representing the market structure of 48 developed and emerging-market countries in North and South America, Europe, Africa and the Pacific Rim. The Index is calculated with net dividends reinvested in U.S. dollars. The Barclays Global Aggregate Bond Index is a market capitalization-weighted benchmark, tracks the performance of investment-grade fixed- income securities denominated in 13 currencies. The Index reflects reinvestment of all distributions and changes in market prices. The Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 Index over the next 30 days. A higher number indicates greater volatility. The BofA Merrill Lynch US High Yield Constrained Index measures the performance of a representative basket of high-yield bonds.
Disclosures This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There is no assurance as of the date of this material that the securities mentioned remain in or out of SEI Funds. There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results. Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI). Neither SEI nor its subsidiaries are affiliated with your financial advisor. © 2015 SEI
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