In BSW Blog, Economic Outlook, Portfolio Commentary, Quarterly Newsletter

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“Man is not disturbed by things, but by his opinion of things.” — Epictetus

Overview & Summary:
The BSW Diversified Growth Portfolio returned 20.40% in 2013, its third-best year since inception in 2003 (its best year was 2003 at 30.73%, followed by 2009 at 22.66%). As a reminder, the Diversified Growth Portfolio has two components, Growth Equities (i.e., stocks) and Alternative Assets (other publicly-traded investments, such as REITs, commodities, precious metals, etc.).

For 2013, BSW’s Growth Equities component returned 23.42% and beat its benchmark (the MSCI All-Cap World Index – the ACWI), which returned 22.80%.

The Portfolio’s Alternative Assets allocation reduced performance during 2013 by -3.02% and was eliminated in June 2013. At the outset of 2013, three Alternative Asset positions were held: gold, long/short commodities, and high-yield bonds. Both gold and high yield were strong investments over their respective holding periods (gold returned a cumulative 41%, while high-yield returned a cumulative 27%), while long/short commodities was a disappointment (-5.38% cumulative return). Although Alternative Assets still have merit and application, the current economic and investment environment is not favorable for them – hence the zero weighting to Alternatives within the Portfolio.

What Worked & What Didn’t:
To provide additional insight into 2013 performance, below please find an examination and evaluation of the Portfolio at the Macro, Sector, and Sub-sector levels.

Macro Allocations:
The portfolio’s macro allocation is its split between the three primary components of global equity markets: the US, Developed Foreign, and Emerging Markets. At the outset of 2013, the Portfolio was overweight to the US, but during the year this was gradually reduced toward a modest underweight (we remain overweight to US Large, but are neutral to US Mid and underweight US Small due to difficult-to-rationalize valuations). Conversely, the Portfolio began 2013 underweight to developed foreign and gradually scaled that allocation up during the year to a modest underweight.  Emerging markets maintained their overweighting throughout the year. This overweight to Emerging Markets was the portfolio’s biggest detractor, as emerging market returns paled in comparison to the US, Japan, and Europe. Our overweight to the US was a strong contributor to performance, though as noted, this overweight was scaled back twice due to concerns about US valuations becoming a bit too exuberant and expensive – particularly small and mid-cap companies.

Here’s a snapshot of the Portfolio’s ending macro allocation relative to the ACWI as of 12.31.13:

Chart 1

Sector Allocations:
Within the Portfolio’s allocations to the US, Developed Foreign, and Emerging Markets, we track how our allocation performed against the predominant benchmark. In other words, for each of the three benchmarks, how did our sector allocation mix do against its respective benchmark? Below is a snapshot that compares these returns:

Chart 2

As the table illustrates, our relative weightings between market capitalizations and within regions (such as Europe versus general EAFE, and Asia versus general Emerging Markets) worked quite well – and enabled the Portfolio to overcome the drag from of our emerging markets overweight.

Sub-Sector Allocations:
In addition to Macro and Sector analysis, each quarter we also evaluate how our individual investment selections or managers performed relative to their benchmark. In other words, if we are utilizing active managers or specialty vehicles, are they outperforming and adding value? The table below identifies any active manager compared to their respective benchmark – during 2013 or since the position’s inception date (if new in 2013).

Chart 3

As the table illustrates, our manager selection has been very beneficial. With the exception of one manager in the emerging markets (in whom we still have tremendous confidence), our active managers and fund selection has been substantially additive to the Portfolio.

In terms of highlights, our best performing position in 2013 was US Small Cap (up a blistering up 38.61%), followed by our actively managed US Large Cap position (up 33.09%). Our poorest performer was the second of our actively managed, emerging markets positions, which returned 0.02% — a good showing relative to the emerging markets index (-2.60%) but still a stark contrast to, say, US Small Cap.

2014 Outlook & Positioning:
A slew of economic indicators and investment data is slated for release during the first 4 weeks of January – including employment reports, Fed minutes, and quarterly corporate earnings. In light of 2013’s strong returns, BSW will be rebalancing portfolios soon to restore allocation targets, skim profits and growth, and reposition portfolios per our 2014 outlook. In general, we are optimistic – particularly with regard to foreign developed. 2014 may be the first year since before the Great Recession when all three legs of the global economic stool (the US, Europe, and the Emerging Markets) are in a synchronized expansion mode. This bodes well for companies and investors, though some areas of the market (such as US internet companies and US small cap) have gotten way ahead of themselves.

Considering the US market’s strong gains on rather lackluster growth, a cyclical correction may be probable in 2014 – especially if the Fed spooks investors with more tapering talk. In the long run, however, a Fed taper is a positive sign, as it indicates that the Fed believes the economy has reached “exit velocity” and no longer needs extraordinary support measures. Although demographics and structural problems are evident, we believe that global economic growth is on the mend – with especially bright prospects in Europe and Asia. We will publish another commentary detailing changes and positioning post rebalancing.

We hope this Update & Commentary provides you with better insight into your BSW Growth Portfolio — and many thanks for reading.  If you would like to discuss these positions or your portfolio in greater detail, please don’t hesitate to contact BSW.  As always, we are happy to help.

David Wolf, Chief Investment Officer

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