There’s a famous scene in the Mel Brooks movie Young Frankenstein where Dr. Frederick Frankenstein (played brilliantly by Gene Wilder) realizes that his assistant Igor gave him “Abby Normal’s” brain to put into his monster. As you can imagine, hilarity ensues. Today, we’re once again talking about “The New Abnormal” — but rather than its impact on a 7-foot monster, we’re instead referring to today’s market environment and the impact it’s having on nonprofit investment portfolios.
We anticipate that 2017 is going to be a rocky year for fiduciaries looking to meet a 7 to 8 percent return in their investment portfolio. In fact, uncertainty is going to be the driving theme. In the political arena, the election of Donald Trump and the UK’s decision to leave the European Union will have an impact on the markets. We believe the markets will respond with increased volatility, regulators will begin the long process of raising interest rates, and a strong U.S. dollar will put increasing currency pressure on global investors. So, what does this mean for nonprofit fiduciaries?
- Finding investment returns isn’t going to get any easier, so fiduciaries have to consider putting all their capital to good use in order to pursue their spending goals. This means that most fiduciaries can’t rely solely on stocks or private capital for returns. They are going to have to seek returns from all areas of their portfolio. Fiduciaries should consider incorporating strategies such as absolute return bond funds, currency strategies, or global bonds, which can provide diversification as well as return potential.
- Global investors are going to have to look closely at the mix of countries they are invested in, and make explicit decisions about global, international, emerging, and frontier equity investments to make sure every dollar invested is worth the risk. To add complexity, investors should factor in the impact of currency on these global investments. Understanding the impact of exchange rates on your overall investment return is critical for U.S. investors when the dollar is strong. Fiduciaries should consider incorporating hedging strategies to minimize the impact of currency risk if there isn’t a specific return attached to it.
- Fiduciaries really need to understand the impact of the global economic environment on their investment portfolio and the risks that each equity market brings to their investment portfolio. For example, we believe U.S. equity markets are unattractive in a longer-term context because they are expensive, however, European equity markets have more compelling opportunities with cheaper valuations, an improving economic environment, and supportive central bank policies.
- And finally, we believe maintaining a mix of actively and passively managed investments will be key to helping seek consistent returns throughout 2017. Active managers are those who dynamically adjust their holdings to capitalize on opportunities and help manage risks. Passive managers are those who try to match the returns of a specific market index. Combining the two styles in your investment portfolio can help ensure that fiduciaries get access to market returns in a cost-effective manner.
In addition to directing your investment committee and service provider to evaluate whether incorporating the above listed strategies into your investment portfolio is the right choice for your organization, there are a few other things board members should consider for 2017. Reviewing your spending policy and your investment policy statement can also have positive effects on your investment program during volatile market environments. Some organizations with high spending rates can benefit from revisiting how those spending rates are calculated as well as whether a high spending rate is sustainable long term. This type of analysis can help align your return needs with your spending priorities. And, if you decide to revise the types of strategies you’re planning to incorporate into your investment portfolio, it’s good to revisit your investment policy statement to ensure that it allows you the flexibility to incorporate those strategies into your investment program.
2017 is sure to be an exciting year, offering few certainties, plenty of potential risks, and hopefully a few moments of levity as we navigate this “Abby Normal” environment. For more details, Russell Investments’ full 2017 Global Market Outlook can be accessed here.
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