Chart of the Week

Weekly chart using economic data to address timely market topics from the Wells Fargo Investment Institute Global Investment Strategy team.

October 17, 2018

Tracie McMillion, CFA, Head of Global Asset Allocation Strategy
Chris Haverland, CFA, Global Asset Allocation Strategist
Bobby Zheng, CFA, Investment Strategy Analyst

Don’t Let Short-Term Emotion Derail Long-Term Strategy

Don’t Let Short-Term Emotion Derail Long-Term StrategySources: Wells Fargo Investment Institute, Morningstar Direct, September 2018. Performance results for the Four Asset Group without Private Capital Portfolio are hypothetical and do not represent an actual portfolio in existence now or during the time period shown. Index return information is provided for illustrative purposes only. Index returns do not represent investment returns or the results of actual trading nor are they forecasts of expected gains or losses a portfolio might experience. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and generally do not reflect deduction for fees, expenses or taxes applicable to an actual investment. Unlike most asset class indices, HFR Index returns reflect deduction for fees. Because the HFR indices are calculated based on information that is voluntarily provided actual returns may be lower than those reported. An index is unmanaged and not available for direct investment. Hypothetical and past performance does not guarantee future results. Please see the end of this report for the definition of the indices and a description of the asset class risks. MGI 4AG No PC = Wells Fargo Investment Institute Moderate Growth and Income Portfolio without Private Capital. Please see disclosures on page 2 for composition of the Moderate Growth & Income Four Asset Group Portfolio without private capital and for representative asset-class indices. This chart was excerpted from the Asset Allocation Strategy In Depth report dated October 11, 2018

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Cumulative performance from October 2007 to August 2018

In 2008 and 2009, the global economy suffered the worst financial crisis since the Great Depression. Subsequently, the S&P 500 Index (dotted line) moved ahead of the hypothetical diversified portfolio and bond portfolio, but with greater volatility. Over the same period, international markets, hedge fund strategies, and commodities have fallen behind.

Does that suggest that now is the time to exit these other asset classes? Not necessarily. Exposure to a globally diverse set of low-correlated assets can smooth the performance ride and better position a portfolio for long-term success.

What it May Mean for Investors

Investors should not let short-term emotions (which can be exacerbated by media reports) derail a disciplined investment strategy. There are many examples of investors timing in and out of markets only to be caught on the wrong side of a market move. At any point in time, one asset class will outperform all others. That does not mean that investors should scrap a diversification strategy. In our opinion, asset allocation is the best way to capture the upside potential of the full investment spectrum through the ups and downs of market cycles.

MGI 4AG No PC = Wells Fargo Investment Institute Moderate Growth and Income Portfolio without Private Capital.
Commodities are represented by Bloomberg Commodity Index; Emerging Market Equity by MSCI Emerging Markets USD Index; Large Cap by S&P 500 Index; Developed Market Equity by MSCI EAFE GR USD Index; Hedge Funds by HFRI Fund Weighted Index; Investment Grade U.S. Bonds by Bloomberg Barclays U.S. Aggregate Bond Index.
Moderate Growth & Income Four Asset Group Portfolio w/o Private Capital = 3% Bloomberg Barclays U.S. Treasury Bill 1-3 Months; 11% Bloomberg Barclays U.S. Aggregate (5-7 year); 6% Bloomberg Barclays U.S. Aggregate (10+ year); 6% Bloomberg Barclays U.S. Corporate High Yield Index; 3% JP Morgan GBI Global Ex-U.S. TR USD Index; 5% JP Morgan EMBI Global TR USD Index; 20% S&P 500 Index; 8% Russell Mid Cap TR USD Index; 6% Russell 2000 Index; 5% MSCI EAFE GR USD Index; 5% MSCI Emerging Markets GR USD; 5% FTSE EPRA/NAREIT Developed TR USD Index; 2% Bloomberg Commodity Index; 3% HFRI Relative Value Index; 6% HFRI Macro Index; 4% HFRI Event Driven Index; 2% HFRI Equity Hedge Index.

Risks Considerations

Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss. All investing involve risks, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors some of which may be unpredictable. Each asset class has its own risk and return characteristics. The risks associated with the representative index asset classes shown in this report include:

Commodities: The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or other factors affecting a particular industry or commodity.

Equity Securities: Stocks are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. The prices of small/mid-company stocks are generally more volatile than large company stocks. They often involve higher risks because of smaller and mid-sized companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.

Fixed Income: Investments in fixed-income securities are subject to interest rate and credit risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. High yield fixed income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment grade fixed income securities. All fixed income investments may be worth less than their original cost upon redemption or maturity. U.S. government securities are backed by the full faith and credit of the federal government as to payment of principal and interest if held to maturity. Although free from credit risk, they are subject to interest rate risk.

Foreign/Emerging Markets: Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

Real Estate: Investing in real estate investment trusts (REITs) have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions.

Hedge Funds: Hedge Funds are only available to persons who are “accredited investors” or “qualified purchasers” within the meaning of U.S. securities laws. Hedge funds trade in diverse complex strategies that are affected in different ways and at different times by changing market conditions. Strategies may, at times, be out of market favor for considerable periods with adverse consequences.

Hedge Strategies: Event Driven strategies involve investing in opportunities created by significant transactional events, such as spinoffs, mergers and acquisitions, bankruptcy reorganization, recapitalization and share buybacks. Managers who use such strategies may invest in, and might sell short, the securities of companies where the security's price has been, or is expected to be, affected by a distressed situation. Equity Hedge strategies maintain positions both long and short in primarily equity and equity derivative securities. Macro managers trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Relative Value strategies focus on exploiting perceived imbalances or valuation discrepancies between related markets or instruments.

Index Definitions

Investment Grade Fixed Income: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based index that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS ABS, and CMBS.

High Yield Fixed Income: Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the U.S. dollar-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB= or below. Included issues must have at least one year until final maturity.

Cash Alternatives/Treasury Bills: Bloomberg Barclays U.S. Treasury Bills (1-3M) Index is representative of money markets.

Commodities: Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements.

Public Real Estate: FTSE EPRA/NAREIT Developed Index is designed to track the performance of listed real-estate companies and REITs in developed countries worldwide.

Hedge Funds: HFRI Fund Weighted Index is a fund-weighted (equal-weighted) index designed to measure the total returns (net of fees) of the approximately 2,000 hedge funds that comprise the Index. Constituent funds must have either $50 million under management or a track record of greater than 12 months. Sub-strategies include: HFRI Event-Driven, Distressed/Restructuring Index, and HFRI Event-Driven (Total) Index.

Developed Market Ex-U.S. Fixed Income: JP Morgan Global Ex United States Index (JPM GBI Global Ex-US) is a total return, market capitalization weighted index, rebalanced monthly, consisting of the following countries: Australia, Germany, Spain, Belgium, Italy, Sweden, Canada, Japan, United Kingdom, Denmark, Netherlands, and France.

Emerging Market Fixed Income: JPM EMBI Global Index is a U.S. dollar-denominated, investible, market cap-weighted index representing a broad universe of emerging market sovereign and quasi-sovereign debt. While products in the asset class have become more diverse, focusing on both local currency and corporate issuance, there is currently no widely accepted aggregate index reflecting the broader opportunity set available, although the asset class is evolving.

Developed Markets Ex-U.S. Equities: MSCI EAFE GR Index is a free float-adjusted market capitalization index that is designed to measure equity market performance across 21 developed market countries excluding the U.S. and Canada.

Emerging Market Equity MSCI Emerging Markets Index (MSCI EM GR) is a free float-adjusted market capitalization index designed to measure equity market performance of emerging markets. The index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates.

U.S. Small Cap Equities: Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.

U.S. Mid Cap Equities: Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000® Index, which represent approximately 25% of the total market capitalization of the Russell 1000® Index.

U.S. Large Cap Equities: S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value.

Inflation-CPI: IA SBBI U.S. Inflation Index is a custom unmanaged index designed to track the U.S. inflation rate

Bloomberg Barclays U.S. Aggregate 1-3 Year Bond Index is unmanaged (Short Term Fixed Income): is unmanaged and is composed of the Bloomberg Barclays U.S. Government/Credit Index and the Bloomberg Barclays U.S. Mortgage-Backed Securities Index, and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities with maturities of 1-3 years.

Bloomberg Barclays U.S. Aggregate 5-7 Year Bond Index (Intermediate Term Fixed Income): is unmanaged and is composed of the Bloomberg Barclays U.S. Government/Credit Index and the Bloomberg Barclays U.S. Mortgage-Backed Securities Index, and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities with maturities of 5-7 years.

Bloomberg Barclays U.S. Aggregate 10+ Year Bond Index (Long Term Fixed Income): is unmanaged and is composed of the Bloomberg Barclays U.S. Government/Credit Index and the Bloomberg Barclays U.S. Mortgage-Backed Securities Index, and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities with maturities of 10 years or more.

HFRI Relative Value Index (HF -Relative Value) maintains positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative, or other security types.

HFRI Equity Hedge Index (HF -Equity Hedge) maintains positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations, and valuation ranges of typical portfolios.

HFRI Macro Index (HF -Macro) is composed of a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency, and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top-down and bottom-up theses, quantitative and fundamental approaches, and long-and short-term holding periods. Although some strategies employ RV techniques, macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments rather than realization of a valuation discrepancy between securities.

HFRI Event Driven Index (HF -Event Driven) maintains positions in companies currently or prospectively involved in corporate transactions of a wide variety including, but not limited to, mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance, or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated and frequently involve additional derivative securities. Event driven exposure includes a combination of sensitivities to equity markets, credit markets, and idiosyncratic, company-specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative) with the realization of the thesis predicated on a specific development exogenous to the existing capital structure.

The HFRI Indices are based on information self-reported by hedge fund managers that decide, on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, LLC (HFR). Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways. Unlike most asset class indices, HFR index returns reflect fees and expenses. Index returns do not reflect any fees, expenses or sales charges. Unlike most asset class indices, HFR index returns reflect fees and expenses.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

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