Achieving Core U.S. Fixed Income Exposure via ETFs

For the third quarter of 2016, the Navigator Fixed Income portfolio gained 1.41% compared to a 0.16% gain for the Barclays Capital Intermediate Government and Credit Index.

The Fixed Income portfolio’s mission is to provide core U.S. fixed income exposure via a mix of solid, proven mutual funds and ETFs. The quarter was a relatively quiet one for bonds broadly, but credit markets did provide leadership.

As a result, the portfolio’s largest credit-oriented positions, Loomis Sayles Investment Grade Bond (LSIIX) and Pioneer Core Bond (PICYX) were top contributors. BlackRock U.S. Mortgage (MSUMX) and Navigator Duration Neutral Bond (NDNIX) were the top detractors.

Consensus continues to grow that the Fed will indeed increase interest rates before the end of the year, and the economy appears to be on a slow and steady growth course.

While the short-term outlook is for higher interest rates, the longer-term outlook remains for muted inflation and muted growth. We see no signs that will change any time soon. In such an environment, we continue to believe that credit will outperform and thus favor it in the portfolio.

Navigator Capital Preservation with Sentry

For the third quarter of 2016, the Navigator Capital Preservation with Sentry portfolio gained 1.87% compared to a 1.70% gain for the Dow Jones Conservative Portfolio Index.

It was a bullish quarter for risk, as we saw high yield bonds outperform Treasuries, small cap outperform large, and emerging markets outperform developed.

Within fixed income, the portfolio allocated towards high yield during the quarter, and the position produced strong returns, even outperforming broad equities. Within equities, the portfolio switched its portfolio to owning low cost ETFs within both the U.S. and international equity spheres, utilizing an approach that is partially low cost indexing and partially factor-investing and currency-hedging based.

Hedging one’s equity exposure during a strong market for equities is an exercise in patience and understanding the proper role of a hedge in a broader portfolio. We continue our constant policy of providing a hedge for the portfolio at all times, while at the same time looking to reduce the costs of hedging by shorting volatility (in small, risk-managed trades).

Looking forward into the rest of 2016, our stance remains mildly bullish, as market breadth has expanded and value stocks appear to be providing new leadership. This unique election year should cause market volatility, but we do not expect to increase the size of our hedge position any time soon. We feel the end of the election could well lead to the end of uncertainty and possibly spark a rally.

Navigator Conservative Growth with Sentry

For the third quarter of 2016, the Navigator Conservative Growth with Sentry portfolio gained 1.76% compared to a 2.32% gain for the Dow Jones Moderately Conservative Portfolio Index. It was a bullish quarter for risk, as we saw high yield bonds outperform Treasuries, small cap outperform large, and emerging markets outperform developed.

Within fixed income, the portfolio allocated towards high yield during the quarter, and the position produced strong returns, even outperforming broad equities.

Among U.S. equity styles, we favored small cap value and High Beta (SPHB), both of which are heavily weighted in financials.

Among U.S. sectors, Technology (via software, internet, small cap tech, and semiconductors) and Financials were the most favored by our ranks. Internationally, Brazil, China, Taiwan, and India were favored as emerging markets got most of the portfolio weight at the expense of Europe in particular. Among alternative-oriented investments, we added a long/short commodity fund, a high yield muni fund, and an event driven equity fund.

Navigator Moderate Growth with Sentry

For the third quarter of 2016, the Navigator Moderate Growth with Sentry portfolio gained 1.89% compared to a 3.53% gain for the Dow Jones Moderate Portfolio Index. It was a bullish quarter for risk, as we saw high yield bonds outperform Treasuries, small cap outperform large, and emerging markets outperform developed.

Within fixed income, the portfolio allocated towards high yield during the quarter, and the position produced noteworthy returns, even outperforming broad equities. Within equities, the portfolio switched its portfolio to owning low cost ETFs within both the U.S. and international equity spheres, utilizing an approach that is partially low cost indexing and partially factor-investing and currency-hedging based.

Among U.S. equity styles, we favored small cap value and High Beta (SPHB), both of which are heavily weighted in financials. Among U.S. sectors, Technology (via software, internet, small cap tech, and semiconductors) and Financials were the most favored by our ranks.

Internationally, Brazil, China, Taiwan, and India were favored as emerging markets got most of the portfolio weight at the expense of Europe in particular. Among alternative-oriented investments, we added a long/short commodity fund, a high yield muni fund, and an event driven equity fund.

Navigator Growth

3.49% compared to a 4.63% gain for the Dow Jones Moderately Aggressive Portfolio Index. It was a bullish quarter for risk, as we saw high yield bonds outperform Treasuries, small cap outperform large, and emerging markets outperform developed. Within fixed income, the portfolio allocated towards high yield during the quarter, and the position produced noteworthy returns, even outperforming broad equities.

Within equities, the portfolio switched its portfolio to owning low cost ETFs within both the U.S. and international equity spheres, utilizing an approach that is partially low cost indexing and partially factor-investing and currency-hedging based. Among U.S. equity styles, we favored small cap value and High Beta (SPHB), both of which are heavily weighted in financials.

Our outlook for 2016 remains mildly bullish, as we are encouraged by the improved market technicals and renewed credit market confidence. We remain more optimistic about international markets, which have undergone a full blown bear market since 2014.

While the 2016 elections will likely lead to some short-term volatility, we believe that the most likely market direction after the election will be upwards as uncertainty will finally be resolved.

Navigator Aggressive Growth

or the third quarter of 2016, the Navigator Aggressive Growth portfolio gained 3.71% compared to a 5.72% return for the Dow Jones Aggressive Portfolio Index. It was a bullish quarter for risk, as we saw high yield bonds outperform Treasuries, small cap outperform large, and emerging markets outperform developed. Within fixed income, the portfolio allocated towards high yield during the quarter, and the position produced noteworthy returns, even outperforming broad equities.

Within equities, the portfolio switched to owning low cost ETFs within both the U.S. and international equity spheres, utilizing an approach that is partially low cost indexing and partially factor-investing and currency-hedging based. Among U.S. equity styles, we favored small cap value and High Beta (SPHB), both of which are heavily weighted in financials.

Among U.S. sectors, Technology (via software, internet, small cap tech, and semiconductors) and Financials were the most favored by our ranks. Internationally, Brazil, China, Taiwan, and India were favored as emerging markets got most of the portfolio weight at the expense of Europe in particular. Internationally, we see Japanese equities on the rise, while Europe continues to be at the bottom of the pack.

Now, however, the market bottom on February 11th looked to have been capitulative among international equities. International equity valuations are compelling, and international equities, particularly emerging markets (which are attractively valued on a relative basis) are beginning to display relative strength. While the 2016 elections will likely lead to some short-term volatility, we believe that the most likely market direction after the election will be upwards as uncertainty will finally be resolved.

Strategist Portfolios

Navigator Fixed Income Total Return

The Fixed Income Total Return (FITR) portfolio entered 2016 in a defensive position owning 100% U.S. Treasuries. The defensive bias immediately paid off, as fear took over and credit markets underwent a dramatic decline into mid-February.

For a brief period high yield bonds yielded the most since 2009. When the trend became extreme and began to reverse, it took less than three weeks for the FITR model to become aggressive and buy back into high yield at the end of February.

Since February, credit markets have been strong, led by a dramatic decrease in high yield bond yields, as sentiment improved with regard to the energy and materials sectors in particular. Our model favored high yield and was at an all-time high coming into the Brexit vote. In just two days, the combined strength in Treasuries and weakness in high yield nearly forced us to sell and become defensive – but only nearly.

The quick, dramatic rally after the two day decline in the aftermath of the vote affirmed our view that the Brexit vote was a sentiment-related and not economy-related event. Since then credit markets continued to gradually strengthen, with yields grinding lower while Treasuries were flat or declined.

Stability (at least) in energy markets, along with recovering foreign markets, served as key supporting factors. Here are some additional developments from the portfolio during the quarter:

The Barclays US High Yield Corporate Bond Index was up 5.50% for the third quarter, while the Barclays US Aggregate Bond Index was up 0.46%. High yield performance was driven by the Energy and Telecom sectors. B and CCC credits were stronger than BB.
As of September 30th, the resulting duration of the FITR portfolio is 3.64, with a current yield of 6.26%. The average maturity is 6.60 years, and average credit quality is B+.
On the quarter, the portfolio’s top contributors were high yield bond ETFs (JNK and HYG), and BlackRock High Yield Bond (BRHYX). The portfolio’s top detractors were the Barclays Short Term High Yield Bond SPDR (SJNK), PIMCO High Yield Spectrum (PHSIX), and AB High Income (AGDYX).
While many commentators voice great concern that high yield bonds are in a bubble, a longer term view reveals that high yield spreads expanded greatly in February, creating a major buying opportunity and have only now returned to near longer term averages. We believe that an option-adjusted spread (OAS) of below 300 basis points represents a roughly fully valued high yield market. Currently the OAS is 480 basis points, with more room to decline.

Navigator Global Equity ETF

For the second quarter of 2016, the Navigator Global Equity ETF portfolio gained 4.53% compared to a 5.30% gain for the MSCI All Country World Index. Within U.S. equity styles, the portfolio favored small cap value stocks, small caps in general, and high beta stocks. The resultant portfolio favored value-oriented companies, and the Energy and Financials sectors.

Overall, the portfolio favored international equities over U.S. equities, with particular emphasis on emerging markets and technology. Financials are an emerging sector in our relative strength rankings, with Japan showing up as a country on the rise.