By William Davis


By way of background, the National Association of Securities Dealers – the NASD – was founded in 1939 to oversee the behavior of brokerage firms under the SEC’s watch. In 1971, the self-regulatory association, much to the dismay of its spread-happy member firms, launched the industry’s first electronic stock quotation system: The National Association of Securities Dealers Automated Quotations, immediately known by its acronym, NASDAQ. Twenty years later, the privately-funded regulator – literally the NASD in NASDAQ – reaped a financial windfall when it divested itself from what had become one of the world’s most valuable marketplaces.

Amendments to the Securities Exchange Act of 1934 allowed the “Commission” to supervise the conduct of its members

Flash forward to 2017, and what had been the NASD is now marking its tenth year as the Financial Industry Regulatory Authority, or FINRA as we all know and love it. Today’s version of the non-governmental organization oversees a multifarious mash-up of some 3,800 U.S. brokerage firms, 160,000 branch offices, and 600,000 registered securities representatives. As regulators go, the FINRA folks are about as good as they come. As investors, however…let’s say they might want to stick to supervising.

A private corporation, FINRA is funded by assessments, fines, and annual fees paid by members

Unique among regulators, FINRA is an active investor of its own money – a not so inconsequential cache of $1.6 billion. The story’s going around now that the organization’s decision to mimic the investment strategies of university endowments like Florida State and the University of Colorado has turned out poorly. How poorly? Over the past 10 years, FINRA’s portfolio – including a $576 million hit in the 2008 downturn – has reportedly netted an average annualized return of just 1.9%. By comparison, endowments with assets over $1 billion produced 5.7%.

FINRA’s operating revenues were more than $800 million in 2016

According to FINRA, its strategy seeks to achieve “lower-risk returns that preserve principal,” lower, apparently, being the operative word here. Since FINRA can rebate fees when revenues exceed forecasts, its sickly investment numbers have financial ramifications for the industry that funds it. We can suggest any number of member firms that might help.

What the equity markets have been doing…

So, who’s afraid of another winning streak? Not us, say U.S. equity traders, as major stock indexes touched another new round of records this period. Most impressive, perhaps, was the large-cap S&P 500 ripping off eight consecutive daily gains before taking a breather on Friday. The run was the big benchmark’s longest since 2013. The Dow and NASDAQ, too, put on good numbers over the two-week stretch, touching all-time highs along the way.

Given the paucity of market-moving news, the interesting aspect of the rally was its exceptionally low volatility. How exceptionally low? On Thursday, the CBOE Volatility Index (VIX) — colloquially referred to as the fear index — closed at its lowest level since inception in 1993. While high VIX readings point to big market moves in either direction, low VIX numbers indicate neither significant downside risk nor significant upside potential. Interesting.

INDEX Friday’s Close One-Week Point Change Year-to-Date Change
DJIA 22,773.67 +424.08 +15.24%
S&P 500 2,549.33 +47.11 +13.87%
NASDAQ 6,590.18 +163.26 +22.42%


What the fixed income markets have been doing…

Yields in the Treasury market rose a bit, with most economic data pointing to further interest rate hikes down the road. The investment-grade corporate market, on the other hand, was driven more by fundamentals like limited supply and light new issuance of the safe stuff. The high yield market for its part was focused on new issuance.

Municipal bonds, meanwhile, continued to be supported by high demand and relatively modest new supply. The big deal, of course, was Puerto Rico, where the U.S. territory’s already-cheap general obligation bonds worked their way closer to zero. Volume in the bonds outpaced any other name in the muni market by far.

FIXED INCOME Period YTD 12 Months Yield
U.S. Treasuries
2.0% -(1.1)% 2.4%
U.S. Investment Grade +0.1% 5.2% 2.8% 3.2%
U.S. High Yield -(0.1)% 7.2% 8.6% 5.4%
U.S. Municipals +0.1% 4.7% 1.4% 2.2%
Non-U.S. Developed NC 7.9% -(1.2% 0.8%


What Fund Architects has been doing…

We felt comfortable reducing risk in the portfolios last month, especially considering how much the broader markets have gained this year. While defensive sectors like Utilities and U.S. Treasury Bonds moved up in our ranking system, in the end it was the higher-risk areas of the financial market that outperformed. The markets never blinked, as they say, and continued to reach new highs throughout September.

For October, we swapped out both of our equity overweights in the Global ETF Portfolio. Global Utilities, on balance a disappointing trade, was replaced with Global Materials, a trade that could prove to be a very interesting one. The materials sector has had exceptionally strong returns year to date, but does not appear ‘overbought’ in our analysis. For the materials sector, think of companies like DowDuPont, BASF, and BHP Billiton, many of which are just returning to levels seen in 2014. We also sold Global Infrastructure, which we had held for several months, and moved in to Global Industrials. The Industrials sector, which is comprised of large multi-national corporations like GE and Boeing, has been slow and steady in 2017.

On the fixed income side, Convertible Bonds continued to top our rankings. The upward trend in convertibles has been remarkably consistent – the position was first added in February and shows no signs of slowing down. As for the Conservative Global ETF Portfolio’s other overweight, we sold our position in U.S. Treasury Bonds (TLH) in favor USD Emerging Market Debt.

From here, it’s reasonable to think the financial markets remain subject to downside surprises. And if volatility ever were to rise, a near-term consolidation or correction in stocks might be in store. Higher volatility may make investing less comfortable for some investors, but volatility cuts in both directions. We’re entirely confident in our Mulit-Factor Ranking System’s ability to identify what’s working.

What the numbers are saying…

  • 6%

The third-quarter rise in emerging-market stocks, bringing this year’s gain to 25%. The asset class is on pace for its best year since 2009.

What the pundits have been saying…

“Cycles usually do not last this long. We all know it can’t go on forever, but I believe we could continue on a positive course for both the economy and the market for several more years.”

  • Byron Wein, vice chairman of Blackstone Advisory Partners

 What great rock n’ rollers from Gainesville have said…

“My vision of a rock n’ roll band wasn’t one that cuddled up to politicians, or went down the red carpet.”

  • Tom Petty, in an interview with the Wall Street Journal in 2009

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.