Market Insights


September 2018

Every month I try to focus ‘Market Insights’ on the current economic environment and also overlay current geopolitical considerations to communicate our thoughts on opportunities in the markets. I had a client meeting this week and was asked a thoughtful question from a committee member that I felt might be of interest to other readers. The committee member asked me, “If the Fed (Federal Reserve) is telegraphing an increase in interest rates, wouldn’t an investor benefit by moving all of their fixed income exposure to bonds with short maturities?”

On initial consideration, this seems to be an obvious strategy as the Fed has been increasing short rates and has signaled that they expect to increase those rates further. If one were to move their portfolio to shorter dated securities, it seems that they could certainly better protect their portfolio from rising rates. If only life could be so straight forward!

The current inflation rate as measured by the Consumer Price Index (“CPI”)1 as of July is 2.9% and historically the 10-year Treasury has yielded 200 basis points (2%) or more over inflation2. Following historical precedence, the 10 year should be trading at about 4.9%. Given that the 10 year Treasury is roughly yielding the inflation rate it appears that there is essentially no term premium available to investors. Do investors no longer demand time value for their money? We don’t think so.

The inflation premium3 on the 10 year Treasury held until the financial crisis and the inception of unconventional monetary policy that followed. The following table shows some interesting relationships:

Date 10-Yr Treasury Yield
(average annual yield)
Annual CPI
(average annual yield)
Inflation
Premium
1962-2007 7.0% 4.3% 2.7%
1978-2007 4.9% 2.7% 2.2%
2008-2018 2.6% 1.7% 0.9%
Current 2.9% 2.9% 0.0%

1 The Consumer Price Index (C.P.I), calculated by the U.S. Bureau of Labor Statistics, is a measure of average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

2 Bloomberg LP: For the period 3/30/1962 through 7/31/2018, the average annual yield of the U.S. 10 Year Treasury Note has been 6.18%. For the same period, the average year-over-year change in the CPI has been 3.9%, resulting in an average term premium of 2.28%.

3 The higher return that investors demand for investing in a long term security where inflation has a greater potential to reduce the real return.

4 Quantitative Easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative Easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The magic of the date ranges presented above is simply that I could only get 10 Year Treasury yields and the CPI Index back to 1962 on my Bloomberg Terminal. The 1978 to 2007 period encapsulates the inflation of the late 1970’s and early 1980’s and then the massive bull market for bonds that followed until the financial crisis ensued. I used the 2008 to 2018 period to consider the inflation premium during the Great Recession up to the current time. Lastly, the Current Inflation Premium is the reading of the 10 Year Treasury as of September 6th and the most recent CPI Index.

Since the Great Recession in 2008, the Fed increased their balance sheet from approximately $800 billion to about $4.5 trillion in order to drive down interest rates. The intent was to lower the cost of borrowing to spur economic activity through corporate investments, to drive interest rates lower to stimulate activity in housing and to allow for the refinancing of higher interest debt. The Fed has started to unwind this massive stimulus but their balance sheet is still about $4.3 trillion.

One concern under investor consideration is the impact in the interest rate market if the Fed were to suddenly unwind their massive positions. In our opinion, that type of trade would cause bond prices to fall and interest rates to rise as a result of an excessive injection of supply into the market. As the Fed has no interest in derailing the economy we consider this to be an extremely low probability event.

There are, however, other factors at play that are influencing the market. First, our central bank was not the only central bank to employ Quantitative Easing4. The European Central Bank, the Bank of Japan and the Bank of England were also employing similar measures. As of the close of business on September 6th, the 10-year Treasury note yields 2.87%. This compares to German, British and Japanese 10-year rates of 0.36%, 1.42% and 0.11% respectively. The spread between U.S. rates and the aforementioned foreign rates has continued to drive foreign demand for U.S. paper.

A second reason that we have seen little upward move in interest rates is that pension funds and insurance companies have a nearly insatiable demand for longer dated securities. In the pension fund arena, many pension plans have been “frozen” to new entrants and also no longer accrue service time for covered employees. Once a pension plan is frozen, an actuary can precisely figure out the duration of the liabilities and the plans can then be managed with an allocation to bonds to match the interest rate distribution to essentially have bonds come due to meet the liabilities of the pension fund. For an insurance company, the demand for longer dated securities is to help offset the long liabilities associated with life insurance and annuities as these products can have very long durations.

We think these technical factors are causing the distortion of the historical relationship between bonds and inflation. As we cannot predict the length or the intensity of the unwinding of the quantitative easing, we are equally unsure as to how this will impact both the level of rates and the relationship of interest rates and the inflation premium. If inflation is truly rising, interest rates should increase but could be offset by the excessive demand for longer dated paper. When the next recession comes, and it will, the Fed will, in our opinion, cut short term rates and this will help longer dated bonds. We continue to think that timing the market is a foolhardy exercise.

There are two core underpinnings of my investment philosophy. The first I learned at the kitchen table from my Dad. He was in the real estate business and always told me not to chase deals and was famous for saying “There’s always another day and there’s always another deal.” The other is a “pithy old saw” that has long been around the markets and I’m not sure who said it first, “the market can remain irrational longer than you can remain solvent.” These two guiding principles mean that we won’t chase any single trade and we definitely know we are smart enough to know that we are not smart enough to time markets.

Until next month.

Core Bond Fund

One Month
(as of 8/31/18)
1 Year
(as of 6/30/18)
3 Years
(as of 6/30/18)
Since Inception
(as of 6/30/18)
Core Bond Fund-I Shares 0.72% -0.28% 2.16% 1.52%
Bloomberg Barclays US Aggregate Bond Index 0.64% -0.40% 1.72% 1.17%
Lipper Core Bond Fund Average 0.52% -0.52% 1.60% 1.05%
Lipper Percentile Rank 27% 16%

*Lipper Percentile Rank is based on risk-adjusted performance. Lipper Category: Core Bond Funds. Number of Funds in Category: 520 (1 Year) and 457 (3 Year).
Gross Expense Ratio 1.04%, Net Expense Ratio 0.50%.

Limited Duration Fund

One Month
(as of 8/31/18)
1 Year
(as of 6/30/18)
3 Years
(as of 6/30/18)
Since Inception
(as of 6/30/18)
Limited Duration Fund-I Shares 0.31% 0.34% 0.83% 0.78%
Bloomberg Barclays Government/Credit 1-3 Year Index 0.35% 0.21% 0.71% 0.75%
Lipper Short Investment Grade Debt Fund Average 0.30% 0.58% 1.12% 1.07%
Lipper Percentile Rank 61% 67%

*Lipper Percentile Rank is based on risk-adjusted performance. Lipper Category: Short Investment Grade Debt Funds. Number of Funds in Category: 340 (1 Year) and 290 (3 Year).
Gross Expense Ratio 1.01%, Net Expense Ratio 0.50%

Large Cap Growth Fund

One Month
(as of 8/31/18)
1 Year
(as of 6/30/18)
3 Years
(as of 6/30/18)
Since Inception
(as of 6/30/18)
Large Cap Growth Fund-I Shares 6.22% 21.63% 11.47% 10.13%
Russell 1000 Growth Index 5.47% 22.51% 14.98% 13.01%
Lipper Multi-Cap Growth Fund Average 4.98% 20.60% 11.46% 10.31%
Lipper Percentile Rank 40% 52%

*Lipper Percentile Rank is based on risk-adjusted performance. Lipper Category: Multi-Cap Growth Funds. Number of Funds in Category: 526 (1 Year) and 469 (3 Year).
Gross Expense Ratio 1.34%, Net Expense Ratio 0.90%.

Large Cap Value Fund

One Month
(as of 8/31/18)
1 Year
(as of 6/30/18)
3 Years
(as of 6/30/18)
Since Inception
(as of 6/30/18)
Large Cap Value Fund-I Shares 2.15% 10.60% 9.58% 7.79%
Russell 1000 Value Index 1.48% 6.77% 8.26% 6.98%
Lipper Multi-Cap Value Fund Average 1.25% 8.41% 7.65% 6.48%
Lipper Percentile Rank 20% 16%

*Lipper Percentile Rank is based on risk-adjusted performance. Lipper Category: Multi-Cap Value Funds. Number of Funds in Category: 377 (1 Year) and 315 (3 Year).
Gross Expense Ratio 1.33%, Net Expense Ratio 0.90%.

Small Cap Fund

One Month
(as of 7/31/18)
1 Year
(as of 6/30/18)
3 Years
(as of 6/30/18)
Since Inception
(as of 6/30/18)
Small Cap Equity Fund-I Shares 4.94% 13.85% 8.06% 8.36%
Russell 2000 Index 4.31% 17.57% 10.96% 10.50%
Lipper Small Cap Fund Average 3.52% 13.99% 9.37% 8.94%
Lipper Percentile Rank 55% 76%

*Lipper Percentile Rank is based on risk-adjusted performance. Lipper Category: Small-Cap Core Funds. Number of Funds in Category: 985 (1 Year) and 814 (3 Year).
Gross Expense Ratio 1.33%, Net Expense Ratio 1.05%.

International Equity Fund

One Month
(as of 7/31/18)
1 Year
(as of 6/30/18)
3 Years
(as of 6/30/18)
Since Inception
(as of 6/30/18)
International Equity-I Shares -2.56% 13.20% 8.56% 7.25%
FTSE All World Ex US Index -2.04% 7.58% 5.59% 4.84%
Lipper International Multi-Cap Fund Average -2.08% 6.01% 4.56% 4.07%
Lipper Percentile Rank >1% >1%

*Lipper Percentile Rank is based on risk-adjusted performance. Lipper Category: International Multi-Cap Core. Number of Funds in Category: 416 (1 Year) and 329 (3 Year).
Gross Expense Ratio 1.56%, Net Expense Ratio 1.10%.

The performance data quoted represents past performance. Past performance is not a guarantee of future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth less than their original cost and current performance may be higher or lower than the performance quoted. For performance data current to the most recent month end, please call 1-844-KC-FUNDS.

Fund performance for the 1 year and Inception to Date period are annualized. The inception date for each of the funds is February 27, 2015

Knights of Columbus Asset Advisors LLC has contractually agreed to waive fees and/or to reimburse expenses to the extent necessary to keep Total Annual Fund Operating Expenses, (excluding interest, taxes, fund brokerage commissions, acquired fund fees and expenses and non-routine expenses) from exceeding the Net Expense Ratio for the respective Funds’ Institutional Shares average daily net assets until February 28, 2018.

Benchmark Definitions



Bloomberg Barclays Government/Credit 1-3 Year Index – benchmark for Limited Duration Fund
The U.S. Government/Credit Index is the non-securitized component of the U.S. Aggregate Index and was the first macro index launched by Barclays Capital. The U.S. Government/Credit Index includes Treasuries (i.e., public obligations of the U.S. Treasury that have remaining maturities of more than one year), government-related issues (i.e., agency, sovereign, supranational, and local authority debt), and corporates. The U.S. Government/Credit Index was launched on January 1, 1979 and is a subset of the U.S. Aggregate Index. The 1-3 year index includes all medium and larger issues of U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds that have maturities of between 1 and 3 years and are publicly issued.

Bloomberg Barclays US Aggregate Bond Index – benchmark for Core Bond Fund
The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). Provided the necessary inclusion rules are met, US Aggregate eligible securities also contribute to the multi-currency Global Aggregate Index and the US Universal Index, which includes high yield and emerging markets debt. The US Aggregate Index was created in 1986.

FTSE All-World Ex-U.S. Index – benchmark for International Equity Fund
The FTSE All-World ex US Index is one of a number of indexes designed to help investors benchmark their international investments. The index comprises Large and Mid cap stocks providing coverage of Developed and Emerging Markets excluding the US. The index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world’s investable market capitalization.

Russell 1000 Growth Index – benchmark for Large Cap Growth Fund
The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

Russell 1000 Value Index – benchmark for Large Cap Value Fund
The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The Russell 1000 Value Index is constructed to provide a comprehensive and unbiased barometer for the large-cap value segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

Russell 2000 Index – benchmark for Small Cap Fund
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.

Consumer Price Index – The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services.

Indices are unmanaged and do not reflect the effect of fees. One cannot invest directly in an index.

Lipper Peer Group Definitions



Lipper Short Investment Grade Debt Classification – benchmark for Limited Duration Fund
Funds that invest primarily in investment-grade debt issues (rated in the top four grades) with dollar-weighted average maturities of less than three years. The Limited Duration Bond fund ranked 184 out of 325 funds measured for the one year ranking period and ranked 184 out of 282 funds measured for the three year ranking period as of June 30, 2018.

Lipper Core Bond Classification – benchmark for Core Bond Fund
Funds that invest at least 85% in domestic investment-grade debt issues (rated in the top four grades) with any remaining investment in non-benchmark sectors such as high-yield, global and emerging market debt. These funds maintain dollar-weighted average maturities of five to ten years. The Core Bond fund ranked 63 out of 512 funds measured for the one year ranking period and ranked 60 out of 444 funds measured for the three year ranking period as of June 30, 2018.

Lipper Multi-Cap Growth Classification – benchmark for Large Cap Growth Fund
Funds that, by portfolio practice, invest in a variety of market capitalization ranges without concentrating 75% of their equity assets in any one market capitalization range over an extended period of time. Multi-cap growth funds typically have above-average characteristics compared to the S&P SuperComposite 1500 Index. The Large Cap Growth fund ranked 281 out of 486 funds measured for the one year ranking period ranked and 252 out of 440 funds measured for the three year ranking period as of June 30, 2018.

Lipper Multi-Cap Value Classification – benchmark for Large Cap Value Fund
Funds that, by portfolio practice, invest in a variety of market capitalization ranges without concentrating 75% of their equity assets in any one market capitalization range over an extended period of time. Multi-cap value funds typically have below-average characteristics compared to the S&P SuperComposite 1500 Index. The Large Cap Value fund ranked 60 out of 350 funds measured for the one year ranking period and ranked 59 out of 302 funds measured for the three year ranking period as of June 30, 2018.

Lipper Small-Cap Core Classification – benchmark for Small Cap Fund
Funds that, by portfolio practice, invest at least 75% of their equity assets in companies with market capitalizations (on a three-year weighted basis) below Lipper’s USDE small-cap ceiling. Small cap core funds have more latitude in the companies in which they invest. These funds typically have average characteristics compared to the S&P SmallCap 600 Index. The Small Cap Equity fund ranked 159 out of 991 funds measured for the one year ranking period and ranked 585 out of 812 funds measured for the three year ranking period as of June 30, 2018.

Lipper International Multi-Cap Core Classification – benchmark for International Equity Fund
Funds that, by portfolio practice, invest in a variety of market capitalization ranges without concentrating 75% of their equity assets in any one market capitalization range over an extended period of time. International multi-cap funds typically have characteristics compared to the MSCI EAFE Index. The International Equity fund ranked 5 out of 420 funds measured for the one year ranking period and ranked 9 out of 330 funds measured for the three year ranking period as of June 30, 2018.