helping investors consider this€¦ · assets—commodity strategies, global real estate and...

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Not FDIC Insured · May Lose Value · No Bank Guarantee INVESTED. TOGETHER. Consider this HELPING INVESTORS JUNE 2014 How real assets work in a diversified portfolio AND WHY WE WELCOME A BORING 2014 by Jaylene Howard, Consulting Director

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Page 1: HELPING INVESTORS Consider this€¦ · assets—commodity strategies, global real estate and global infrastructure. Because most of us are already familiar with the role stocks (growth)

Not FDIC Insured · May Lose Value · No Bank Guarantee

INVESTED. TOGETHER.™

Consider thisHELPING INVESTORS

JUNE 2014

How real assets work in a diversified portfolio AND WHY WE WELCOME A BORING 2014

by Jaylene Howard, Consulting Director

Page 2: HELPING INVESTORS Consider this€¦ · assets—commodity strategies, global real estate and global infrastructure. Because most of us are already familiar with the role stocks (growth)

Russell Investments // Helping investors // Consider this

From the author.It’s been an interesting year so far for the markets. As of this writing (on May 30, 2014), the Russell 3000® Index closed at an all-time high of 1147.18. Even so, the U.S. stock market has not been the runaway leader that it was over the last several years.

As you’ll see inside, the Russell 3000 Index is up over 4% year-to-date. Real assets, however, have been outperforming other asset classes, which is why we’ll take a closer look at the role they can play in a diversified global portfolio. Then we’ll discuss Russell’s outlook for the remainder of 2014.

Jaylene Howard Consulting Director

Page 3: HELPING INVESTORS Consider this€¦ · assets—commodity strategies, global real estate and global infrastructure. Because most of us are already familiar with the role stocks (growth)

Russell Investments // Helping investors // Consider this

Why, and how, we diversify with real assets.

At Russell, we believe in diversification. That’s why we build globally diversified portfolios with a broad mix of funds that include stocks, bonds and alternatives. Within alternatives are a group of investments we call real assets—commodity strategies, global real estate and global infrastructure.

Because most of us are already familiar with the role stocks (growth) and bonds (income and ballast) generally play in a diversified portfolio, we thought it would be a good time to look at what real assets bring to a diversified portfolio. Then we’ll review how real assets have performed over the last two years compared to U.S. stocks and bonds.

Real assets add an extra layer of diversification.The reason we use commodity strategies, global real estate and global infrastructure in our asset allocation process is to build deeper diversification—although it does not assure a profit or protect against loss—into our portfolios. But there is more to the story than that. By allocating a portion of the portfolio to real assets, we’re trying to accomplish three things:

1. Deliver enhanced diversification beyond stocks and bonds2. Increase the potential for attractive returns over the long-term3. Provide a possible buffer against inflation

When we talk about commodity strategies, we’re not just talking about oil and gold. We’re referring to a far broader mix of natural resources that also includes agriculture, livestock, other metals like zinc and copper and, of course, natural gas, oil and gasoline.

Similarly, when we talk about global real estate, we are talking about investing in companies around the world that own interests in apartments, shopping centers, office buildings, warehouses, and hotels, to name a few.

What do we mean by global infrastructure? Here we are talking about services that are essential for a functioning economy. These companies fall into four basic categories that include transportation (e.g. toll roads, bridges, rail), utilities (e.g. electricity, water treatment, renewable energy), communications (e.g. cable and wireless networks, telecom lines, towers, satellite systems), and social (e.g. hospitals, schools, courts, public housing).

As you can see, commodity strategies, global real estate and global infrastructure encompass a wide range of industries located throughout the world and can present new opportunities, as well as new risks. However, we believe this can help you gain global exposure to new areas of the market that historically have had a lower correlation to stocks and bonds. Lower correlation simply means that in the past, real assets were less likely to move in the same patterns and directions as either stocks or bonds. The goal here is to try and provide a smoother ride for investors should equity or bond markets experience a rough patch. We’ll return to the idea of lower correlations soon. First, let’s review some recent performance to understand why we like the potential diversification benefits of real assets so much.

›There’s more to commodities than just oil and gold.

Page 4: HELPING INVESTORS Consider this€¦ · assets—commodity strategies, global real estate and global infrastructure. Because most of us are already familiar with the role stocks (growth)

Russell Investments // Helping investors // Consider this

› None of us can predict what will happen in the markets over the short-term.

Real assets have turned around this year.

The blue bars tell the story.

A quick look at the chart above shows that real assets (the blue bars) collectively underperformed the U.S. equity market in 2013. Global Infrastructure fared well while commodities struggled on the heels of slower than expected growth worldwide and global real estate faced a headwind due to rising interest rates. But that changed in 2014 as interest rates declined. As of May 31, 2014, commodities, global real estate and global infrastructure are handsomely outperforming U.S. equities, U.S. bonds and the hypothetical balanced portfolio. This is why we believe diversification is so important. None of us can predict with any accuracy what will happen in the markets over the short-term. So the goal with diversification is to spread the risks—and sources of returns—around as widely as possible to help manage the ride. Real assets help us do that.

Diversification isn’t all sunshine or all shade.

“In real life, you diversify because at the end of the day you do not know what will happen. If you do it right, some elements of your portfolio will be in the shade while other parts may be having their day in the sun.” Our chief market strategist Erik Ristuben uses this simple metaphor to help investors understand that diversification can’t guarantee a profit or protect against loss but what it can do is help you manage the ups-and-downs of the market and stay invested so that you meet your long term goals.

That’s a realistic way to think about a diversified portfolio, and real assets help add to that diversification by offering lower historical correlations to traditional stocks and bonds. So whether parts of your portfolio are sunning themselves or cooling off, it’s important to recognize that they are more powerful together as a whole—over the long-term—than they are separately over the short-term.

Commodities represented by Dow Jones-UBS Commodity Index; Global REITs represented by FTSE EPRA/NAREIT Index; Global Infrastructure represented by S&P Global Infrastructure Index; U.S. Equity represented by Russell 3000® Index; U.S. Bonds represented by Barclays U.S. Aggregate Bond Index; Non-U.S. Equity represented by Russell Developed ex-U.S. Index; Emerging Markets represented by Russell Emerging Markets Index; Hypothetical balanced portfolio represented by 30% U.S. equity, 20% Non-U.S. Equity, 5% Emerging Markets, 35% U.S. Bond, 5% REITs, 5% Commodities.

Other time periods may produce different and less favorable results.

Indexes are unmanaged and cannot be invested in directly. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

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U.S. BondsU.S. Equity Hypothetical Balanced Portfolio

Global Infrastructure

Global REITs

Commodities

Real assets had a tough year in 2013 (1/1/2013–12/31/2013)

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Commodities

But 2014’s been a different story (1/1/2014–5/31/2014)

Page 5: HELPING INVESTORS Consider this€¦ · assets—commodity strategies, global real estate and global infrastructure. Because most of us are already familiar with the role stocks (growth)

Russell Investments // Helping investors // Consider this

› We don’t see interest rates rising until mid-2015.

When boring is good.

What to expect for the rest of 2014.

As far as the stock market is concerned, 2014 is shaping up to be a pretty boring year. And we’re okay with that. As of May 31, 2014, the broad market represented by the Russell 3000® Index is up just 4.32% for the year. Compare that to the double-digit returns of 2012 and 2013, where the market was up 16.42% and 33.55% respectively, and 2014 seems a bit dull.

But we see this muted performance as a good thing. In fact, at the start of the year we thought 2014 would be a year of validation—one where robust growth in developed economies would be necessary to validate the strong returns of 2013. However, an unusually cold winter led to slower economic growth than we’d anticipated. Over the next few months, we expect the U.S. economy to gather some momentum as the effects of the winter weather fade.

Moderate growth and low inflation.

Our strategists are forecasting moderate growth and low inflation in the U.S., with employment strengthening to around 215,000 new jobs per month. Then there is the matter of the Federal Reserve. Russell’s strategists do not think the Fed will begin its gradual process of raising interest rates until probably a year from now.

Under this scenario, relatively mild returns from the stock market would be viewed as a healthy and reasonable response. Stocks are also likely to perform better than bonds going forward. While it is possible that equity markets could continue rising at the pace we saw over the last several years, it would not be sustainable under our current view. This is why we welcome the somewhat boring returns we’ve experienced so far this year, and why we have a similarly reserved view for the remainder of the year.

Of course, anything could happen along the way to tip the scales. We think that volatility could visit the markets again and that may make some investors uncomfortable. There are also risks that growth in Europe could disappoint or geopolitical disturbances could rise there or elsewhere. But that’s why we diversify and take a long-term view on investing. That’s why we sincerely hope you do, too. Have a nice summer and we’ll see you next quarter.

Page 6: HELPING INVESTORS Consider this€¦ · assets—commodity strategies, global real estate and global infrastructure. Because most of us are already familiar with the role stocks (growth)

Russell Investments // Helping investors // Consider this

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. the information contained in this piece should not be considered investment advice to buy/sell any securities referenced. No investment strategy can guarantee a profit or protect against a loss.

These views are subject to change at any time based upon market or other conditions.

Bond investors should carefully consider risks such as interest rate, credit, default and duration risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield (“junk”) bonds or mortgage-backed securities, especially mortgage-backed securities with exposure to sub-prime mortgages. Generally, when interest rates rise, prices of fixed income securities fall. Interest rates in the United States are at, or near, historic lows, which may increase a Fund’s exposure to risks associated with rising rates. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries.

Exposure to the commodities markets may subject investments to greater volatility than investments in traditional securities, particularly if the investments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or sectors affecting a particular industry or commodity and international economic, political and regulatory developments. The use of leveraged commodity-linked derivatives creates an opportunity for increased return, but also creates the possibility for a greater loss.

Investments in infrastructure-related companies have greater exposure to the potential adverse economic, regulatory, political and other changes affecting such entities. Investment in infrastructure related companies are subject to various risks including governmental regulations, high interest costs associated with capital construction programs, costs associated with compliance and changes in environmental regulation, economic slowdown and surplus capacity, competition from other providers of services and other factors. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries.

Specific sector investing such as real estate can be subject to different and greater risks than more diversified investments. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risk to real estate investments. Fund investments in non-U.S. markets can involve risks of currency fluctuation, political and economic instability, different accounting standards and foreign taxation.

Russell 3000® Index: measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

Russell Investment group, a Washington USA corporation, operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of the Northwestern Mutual life Insurance Company. The Russell logo is a trademark and service mark of Russell Investments.

Russell Financial Services, Inc., member FINRA, part of Russell Investments.

Copyright © Russell Investments 2014. All rights reserved.

First used June 2014 RFS 12858

› About RussellFor more than 40 years, we’ve helped guide the investments of some of the world’s largest companies, foundations and pension plans. Working with your financial advisor, you can benefit from this same expertise through our solutions that are strategically designed to address investors’ wide-ranging investment needs and objectives. No matter what stage of life you are in, we believe how you invest matters. That’s why we provide investment solutions that are designed with your goals in mind.

Visit www.russell.com for more information.