Alternatives continue to shine

The third quarter started on a high note. Optimism about easing inflation and minimal damage to the economy briefly returned to the markets after the sharp selloff in the first half of the year. Stocks and bonds both experienced solid rallies.

Things turned dark again, though, when the Federal Reserve sharpened its rhetoric mid-quarter, communicating to investors that it would ratchet up rates decisively until inflation was well under control. Intra-quarter, the markets seesawed more than 10%, but once the dust settled stocks had fallen another -6.8% in the quarter.

Westmount’s stock allocations are designed to track the global stock market in a highly tax-efficient and very low-cost manner. We seek the high average returns that stocks have long delivered as the reward for enduring significant volatility and varied annual returns along the way. Consistent with this objective, our clients’ stock portfolios largely outperformed the global markets by a bit over 1.0% and finished down -5.8% for the quarter (similarly, for the year through Sept. 30, stocks here and abroad are down -25.6%, and Westmount stock portfolios are down -24.6%).

An Unprecedented Year for Bonds

While stocks continued to receive most of the headlines, within the investment community bonds were the much bigger story. Stocks have experienced severe selloffs many times in the past, but this year’s poor performance for bonds is unprecedented. As the Fed initiated additional jumbo-sized interest rate hikes to cool the economy, bonds sold off sharply, continuing the trend from the first half of the year, and finished the quarter down another -4.8%.

Heading into the fourth quarter, Westmount’s bond portfolio maintained its positioning of very low sensitivity to rising interest rates while taking very selective credit risk. The positioning was well-rewarded, as our bonds were down only -1.3% (for the first three quarters of the year, the bond market is down an astonishing -14.6%, while our clients’ bond portfolios are down around -5.1%).

Alternatives Continue to Shine

The brightest spot in client portfolios continues to be alternative assets. We have specifically targeted a segment of this broad asset category that focuses on real estate and corporate loans that are collateralized by real estate and other tangible assets. Unlike many traditional fixed income securities, private loans tend to be floating rate in nature, meaning payments to the investor rise as interest rates go up. The high income from these loans has continued to provide investors a healthy cash flow stream, and their floating rate feature has largely protected them from price declines as rates have shot up. Despite the high volatility of the quarter, our alternative assets provided a smooth ride, finishing the quarter up roughly +1.9% (and they’re up approximately +5.6% for the year through Sept. 30).

It is impossible to know where the markets are headed in the near-term, largely because it’s way too soon to know what the ultimate impact of the Fed’s interest rate hikes (and other global events) will be on the economy. That said, markets and economies are cyclical in nature, and every previous decline has been followed by a meaningful recovery; we anticipate a similar outcome for this cycle as well. We believe the financial markets have largely priced in the scenario of a modest recession, though we could experience a more severe economic downturn. Once there is greater clarity about the economy, and the expectation of a recovery from any weakness, the markets will respond accordingly and resume their long-term climb. In the meantime, we will maintain our tactical positioning in all three main portions of our clients’ portfolios and seek to capitalize on particularly attractive opportunities that may arise.