It’s been said that finance is a set of social conventions, and much of the financial industry is an arena for battling over those conventions. In that sense, the story of Libor — the London interbank offered rate — is the perfect finance story.
The tale begins in 1986 when Libor was created to help banks set interest rates on big corporate loans. Intended to be little more than an invisible bit of financial wiring hidden deep below the surface, the British Bankers’ Association, or BBA, simply asked banks to estimate how much it might cost them to borrow, did the arithmetic, and posted the results. An honor system, if you will, amongst London’s clubby financiers.
American banks adopted Libor to determine what borrowers paid on variable-rate mortgages, student loans, and credit cards
Flash forward 10 years or so, and Libor, for reasons known only to the financial gods, has literally become a foundation of global finance. And bankers — in their role as providers of the numbers that affect profitability of their own loan portfolios — have become quite skilled at manipulating Libor in the favor. In other words, the world’s most important number is based on guesswork from banks that have financial interest in the outcome of their guesswork.
The rate underpins more than $3 trillion in syndicated loans, around $1.5 trillion in commercial mortgages, and $1.44 trillion in residential mortgages
In the final chapter, more than a dozen banks have paid roughly $10 billion in penalties related to fraudulent Libor activities. The BBA has disbanded. Senior executives have lost their jobs. And otherwise nameless traders like Tom Hayes — known to colleagues as Rain Man for his brainy but socially awkward behavior — are in jail.
As a cheerless epilogue, U.K. regulators announced last week that Libor will be phased out altogether.
Studies have estimated that hundreds of trillions of dollars of financial contracts world-wide are based on the benchmark
We’ve also heard it said that it’s possible to get too cynical about the world of finance and its shenanigans. Hard to see how you could.
What the equity markets have been doing…
With a nice boost from energy stocks and no meaningful surprises in second quarter earnings reports, stocks moved ahead across the two-week stretch. The blue-chip Dow performed best among the major benchmarks. Among the important market sectors, healthcare stocks, for any number of reasons, fared poorest.
The period’s economic data were mixed and had little impact on stock prices. Important reports included existing home sales, which declined in June, and the Conference Board’s gauge of consumer confidence, which increased. Less encouraging news came from the manufacturing sector, with core capital goods orders contracting slightly. On Friday, the Commerce Department released its initial estimate of second-quarter growth, which showed GDP expanding slightly below expectations.
|INDEX||Friday’s Close||One-Week Point Change||Year-to-Date Change|
What the fixed income markets have been doing…
Despite word out of the Fed’s policy meeting that the central bank will begin reducing its holdings of mortgage-backed securities and Treasuries “relatively soon,” Treasuries barely moved for the period. The investment grade and high-yield traders also ignored the Fed remarks and focused instead on quarterly earnings reports, which did not contain any major surprises. The municipal new issuance calendar was again relatively light, which continued to drive returns and activity in the secondary market.
|FIXED INCOME||Period||YTD||12 Months||Yield|
|U.S. Investment Grade||-(0.1%||4.6%||1.9%||3.1%|
|U.S. High Yield||-(0.2)%||6.1%||10.8%||5.4%|
What Fund Architects has been doing…
While prices didn’t change too much over the last two weeks, there was plenty going on in the background. Second quarter gross domestic product growth was announced, the Federal Reserve held a policy meeting, and Washington was in turmoil. Most importantly, at least from where we sit, investors saw a rash of corporate earnings releases, with more than half of the companies reporting beating expectations.
In that environment, we’re pleased with the performance of the Fund Architect Portfolios. For its part, the Global ETF Portfolio, despite a slight relative drag from our healthcare position, only slightly underperformed the MSCI All-Cap Index, which we consider to be an aggressive target. The Conservative Global ETF Portfolio, meanwhile, nicely outperformed the Barclays US Aggregate, in no small part due its overweight position in Convertibles.
As we begin the month of August, the Investment Committee, based on our Multi-Factor Ranking System, is making a few changes to the Portfolios.
This month, we’ll be trading the Global Healthcare (IXJ) position for Global Consumer Discretionary (RXI). The healthcare sector was essentially flat for July, and both our existing position in Global Infrastructure (IGF) and our new trade to Consumer Discretionary moved ahead in the rankings. We’ll also be making a strategic change in the qualitative component of the Portfolio, swap our S&P 500 500 exposure for JP Morgan Diversified US Large Cap (JPUS), a ‘smart beta’ ETF we think offers us better opportunity for a long-term hold.
In the Conservative Global ETF Portfolio, we’ll be swapping out of U.S. Preferreds (PFF) into High Yield Bonds (JNK), a position we’ve held before.
From here, we think the Portfolios are nicely position for the current macroeconomic backdrop. This environment has been friendly for our strategy and we don’t expect that to change soon.
What the numbers are saying…
The expected increase in earnings at S&P 500 companies in the second quarter, following a 15% increase in the first. The U.S.’s largest companies are on pace to post two consecutive quarters of double-digit profit growth for the first time since 2011, helped by years of cost-cutting, a weaker dollar, and stronger consumer spending.
What the pundits have been saying…
“The retail industry is clearly facing headwinds. The internet has made the value proposition for a lot of shopping malls less relevant.”
- Nadeem Meghji, head of North American real estate at Blackstone
“People say the internet killed bricks-and-mortar retailers. But bricks and mortar killed itself. People say they don’t know how we’ll survive, but we do it by adapting.”
- Greg Maloney, chief executive for Americas retail at real estate investment and management company JLL
What people have been saying…
“We have to have projects that are resilient in a world where oil has peaked. When it will happen we don’t know, but that it will happen we are certain.”
- Ben van Beurden, Chief Executive, Royal Dutch Shell
The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.