HKFS Investment Advisory Committee
Meeting Summary
March 30, 2015
Committee members present at the March meeting:
Ann McCorkindale
Matt Morey
Jim Siemonsma
MARKET REVIEW:
Dow
S&P 500
NASDAQ
3 Mo. T-Bill
10 Yr. T-Note
Ivan Gruhl
Jim Herrig
Mike Gasperi
Rick Hageman
3/27/15
17,713
2,061
4,891
2/13/15
18,019
2,097
4,894
12/15/14
17,181
1,990
4,605
3/11/14
16,351
1,868
4,307
0.04%
1.95%
0.01%
2.02%
0.01%
2.12%
0.05%
2.77%
Economists’ forecasts of real (inflation-adjusted) GDP growth in 2015 fell slightly over the
past month as they continued to trim their estimates of economic growth in the current
quarter based on expectations that severe winter weather and a West Coast port slowdown
temporarily depressed activity more than previously believed. Nonetheless, real GDP this
year still is expected to register its best calendar-year advance since 2005 and economists
continue to forecast that growth in 2016 will slow very little, if at all, from this year’s pace.
The predicted above-trend rate of real GDP growth this year and next is forecast to further
tighten conditions in labor markets, dropping the unemployment rate this year to its lowest
level since 2007. Inflation has fallen precipitously since last summer due in large part to an
approximate 50% plunge in crude oil prices. However, crude oil prices stabilized by late
January and gasoline prices have risen for the past several weeks. As a result, economists
predict that inflation will rebound from the depressed levels of Q1. Further improvement in
labor market conditions, coupled with expectations that inflation is poised to turn upward in
the near term, will likely prompt the FOMC to drop the term “patient” from its March 18th
policy statement. Doing so will open the door, but not guarantee, that the FOMC will begin a
gradual increase in interest rates at its mid-June meeting.
Consensus estimates: (changes in bold)
GDP
CPI
Unemployment
2015 2016 2015 2016 2015 2016
Mar 3.1
2.9
5.4
5.0
0.3
2.2
Feb
3.2
2.9
2.3
0.4
5.4
5.0
Pers Cons Exp
2015
2016
3.3
2.8
3.3
2.8
10 Yr Note
3 Mo TBill
1Q15 1Q16 1Q15 1Q16
2.0
2.9
0.0
1.0
0.1
1.1
2.0
2.9
Internal Use Only, Not to be Distributed to the Public
STOCK MARKET:
In February the Dow Jones Industrial Average was up 6.01%, the NASDAQ was gained
7.25%, and the S&P 500 was up 5.75%. Overseas, the MSCI ACWI Ex USA was up 5.35%;
while EAFE was up 5.98% and emerging markets were up 3.10%.
The HKFS/Schwab Growth Model grew 4.86% in February, and the Equity Income
Model was up 3.75%, both underperforming the 70% S&P 500 / 30% MSCI ACWI Ex-US
custom benchmark gain of 5.63%. Over the last twelve months the Growth Model was up
11.72% and the Equity Income Model is up 9.93% vs. the 70/30 custom benchmark gain of
11.01%.
Over the past 12 months attribution analysis indicates our style weighting decisions resulted
in a -0.05% detraction (with large growth adding the most return while international
detracted the most) to the growth model. Our active managers added 1.42% to
performance (with large growth ETF and international developed value managers adding the
most and large value ETF detracting the most). Five of the thirteen funds in the portfolio
outperformed their respective benchmarks in February. The highest performing funds on an
absolute basis for the month were Janus Venture at 8.04% and Schwab U.S. Large Growth
ETF at 6.58%.
An actual HKFS/SEI Growth Model Portfolio grew 5.35% in February. On the SEI
platform the Small Cap Growth fund had the highest absolute performance with a gain of
7.59%. Over the last twelve months the model was up 8.95%.
An actual HKFS/ETF Growth Model Portfolio grew 4.77% in February. On the ETF
model platform, the Schwab U.S. Large Growth ETF had the highest absolute performance
at 6.58%. Over the last twelve months the model was up 11.14%.
Monthly Fund Review: Schwab Large Value ETF- the current offering- SCHV, has begun to
underperform the Russell 1000 Value benchmark, but with reason. The Fund does not mimic
that benchmark, but rather the Dow Jones S&P Large Value Index. While SCHV is appearing
to underperform against our Russell benchmark, it is not on ‘watch’ status. It has stayed in
the top 50% of its Large Value peers for the last 1, 3 & 5 year periods.
The Committee believes a passive fund in this space is rational, however, fund availability
with no transaction fees are limited. Schwab has presented information comparing and
contrasting fundamentally weighted index funds vs. market-weight index funds. The
Committee will review this information and move forward with a change if warranted. In
addition, the Committee is reviewing changes to the Equity Income domestic/foreign
allocation, and will research adding an additional developed market manager.
The Investment Advisory Committee reviewed model growth funds currently on ‘watch’
statusThe following stock funds are on ‘watch list’ status:
Name
Lazard Emerging Markets
Goldman Sachs Growth Opp.
Reason
Std. Deviation, 12-mo Return, Perf Rank
Mgmt Change
HKFS Investment Advisory Committee Summary, March 30th, 2015
Current Status
Hold
Hold
2
Internal Use Only, Not to be Distributed to the Public
Lord Abbett Intl Dividend
Janus Venture
Std. Deviation, 12-mo Return
Mgmt Change
Hold
Hold
MUTUAL FUND WATCH LISTS:
The following criteria set by the Investment Advisory Committee places funds
used on the Schwab platform on ‘watch list’ status:
 Significant news event concerning fund family, fund or manager (i.e.: scandal,
buyout, etc.)
 Change in fund management that affects over 33% of the management team
 Change in fund investment style at the prospectus level
 % Rank Category over last 12 month and 3 year period at or above 50% (i.e.:
not performing in at least top 50% of peer fund group)
 Combination of 3-yr standard deviation at 10% above benchmark and 12-month
return below benchmark
 Additional items at discretion of Committee
(SEI Fund managers are monitored by SEI Trust)
Lazard Emerging Markets Fund:
(added to watchlist 1/21/15)
The Lazard Emerging Markets Fund was added to the watch list due to the combination of
3yr standard deviation at 10% above benchmark and 12-month return below benchmark.
LZOEX gained 3.33% vs. 5.01% for the MSCI EM benchmark over the past twelve months.
The fund’s standard deviation is 15.58 vs. 13.44 MSCI EM. Additionally, the 3-month and
3yr peer rankings have fallen below 50% (data through 2/28/15).
In 2014, LZOEX was hurt by its allocation to Russian stocks, and even adding to some of
them. Sberbank began 2014 as the fund’s top holding, with 3.6% of assets, and Gazprom
had 1.9%. Both stocks were slammed, as were the fund’s other Russian holdings, with the
ruble’s plunge adding to the pain. Portfolio manager James Donald bought even more- he
says that even with their substantial risks, their dominant market positions and deeply
discounted prices make them appealing long-term holdings. Considering how hard that
market and currency were hit, the fund’s showing- it’s 4% loss was just 1% below the
category average.
LZOEX uses a relative value approach, shying away from a strict deep-value style, often
ending up in the blended category. The fund’s country weightings often differ markedly from
those of the index. Most notably, the manager was long reluctant to buy stocks in China,
considering them much more expensive that comparable choices elsewhere. The fund had
almost no exposure in China until 2012 and was still significantly underweight at 12% by
year-end 2013. Conversely, it had a relatively high stake in South Africa, but was about
market weight by 2014.
Turnover is very low, falling from about 50% prior to 2010 to 16% in 2013. The category
average is about 75%. Stock ownership is capped at 5% of assets, and less for smallercaps. The fund does not hedge its currency exposure.
Recommendation: Hold and continue to monitor relative performance.
Lord Abbett Int’l Dividend:
(added to watchlist 2/18/15)
HKFS Investment Advisory Committee Summary, March 30th, 2015
3
Internal Use Only, Not to be Distributed to the Public
The Lord Abbett Int’l Dividend Fund was added to the watch list due to performance falling
to the bottom half of its peers over the past 12-month and 3-year periods. LIDAX lost 1.02% over the past twelve months (peer rank of 26) and has returned 5.88% annualized
over the past three years (peer rank of 84) (data through 2/28/15). The fund has
underperformed its benchmark (MSCI ACWI Ex-USA) for the past 3 and 12 month, and 3 &
5 year periods.
Stock selection within the industrials and consumer discretionary sectors contributed to
relative performance during 4Q14. Additionally, the Fund benefitted from an underweight
position in the materials sector.
However, stock selection within the healthcare and consumer staple sectors detracted from
last quarter’s performance. Shares of Sanofi, a globally diversified healthcare company, fell
after weak Q3 results due to lower revenues and contracting margins. Additionally, Swiss
Roche Holding Ltd., a pharma and diagnostics company, struggled following negative news
on in product pipeline.
Recommendation: Hold and continue to monitor relative performance.
Goldman Sachs Growth Opportunities:
(added to watchlist 2/18/15)
The Goldman Sachs Growth Opportunities Fund was added to the watch list due to another
management change. GGOAX has gained 10.38% over the past twelve months (peer rank
of 32) and has returned 16.48% annualized over the past three years (peer rank of 35)
(data through 2/28/15). The fund has underperformed its benchmark- Russell Midcap
Growth, during those periods.
Craig Glassner, managing director and portfolio manager on the Growth Equity team, is
leaving the firm. Glassner shared PM responsibility for GGOAX with Steve Barry and Ashley
Woodruff. Glassner’s research responsibilities for the healthcare sector will be absorbed by
Tim Leahy and Anant Padmanabhan. Leahy has 16 years of investment experience, 10 of
which are with the Growth team. Padmanabhan has 10 years of research experience. Both
are members of the healthcare research team.
Manager Steve Barry has been lead manager of this fund since 1999. Steve is also CIO of
the fundamental equity team at GSAM, overseeing the firm’s U.S. and global equity teams,
as well as CIO of the U.S. growth equity group under that umbrella, and a manager on eight
other strategies within that group. The Growth Equity team consists of 14 investment and
three risk professionals, with the senior leaders averaging 17 years of investment
experience.
Unfortunately, turnover has been high in recent years, partly in conjunction with the firm’s
decision the relocate in Tampa, FL based team to NY. Longtime manager Dave Shell left, as
did a handful of analysts in late 2011. There was a second wave of turnover in April 2013,
when co-manager Scott Kolar departed along with a few more analysts. Analyst Craig
Glassner was promoted to co-manager in 2013, and over the next year, the firm hired five
new analysts for this team, representing one third of the overall group.
Recommendation: Hold and monitor relative performance.
Janus Venture:
(added to watchlist 3/30/15)
HKFS Investment Advisory Committee Summary, March 30th, 2015
4
Internal Use Only, Not to be Distributed to the Public
The Janus Venture Fund was added to the watch list due to a management change. JAVTX
has gained 16.60% over the past twelve months (peer rank of 1) and has returned 19.75%
annualized over the past three years (peer rank of 5) (data through 2/28/15). The fund has
outperformed its benchmark- Russell 2000 Growth, during those periods.
Maneesh Modi, co-manager with Jonathan Coleman, left Janus at the end of February 2015
to join another firm. He had been an analyst on Janus’ small and mid-cap team for six
years. Coleman and Modi took over the fund in May 2013. Coleman has been at Janus since
1994 and has managed various small and mid-cap equity funds since. He is currently Head
of Growth Equities at Janus after serving as Equities CIO for 7 years. He is still backed by
six small and mid-cap analysts supporting 3 funds, with an average of 9 years’ tenure at
Janus.
Recommendation: Hold and monitor relative performance.
BOND MARKET:
At market close on March 27th, the 3-month T-Bill was yielding 0.04%, up 0.03% from last
month. The 10-year T-Note was yielding 1.95%, down from 2.02% at this time last month.
The spread between the 3-month and 10-year notes tightened from 2.01% to 1.91%. The
Barclays U.S. Aggregate Bond Index was down -0.94%.
An actual HKFS/Schwab Taxable Income fund portfolio grew 0.53% in February;
the SHO model was up 1.16%, both outperforming the Barcap U.S. Aggregate Index loss
of -0.94%; the HKFS/SEI Taxable Income fund portfolio was up 0.38%. Four of the
seven Schwab model funds outperformed the Barcap Aggregate.
The weighted duration of the taxable bond fund portfolio on the HKFS/Schwab platform held
at 3.1 in March from February. The weighted duration of the taxable bond fund portfolio on
the HKFS/SEI platform was down at 3.9 years in February.
An actual HKFS/Schwab Municipal Income fund portfolio had a loss of -0.97% in
February, outperforming the Barcap Municipal Index loss of -1.03%. The duration of the
municipal bond fund portfolio on the HKFS/Schwab platform fell to 6.0 in March from 6.3
last month. The HKFS/SEI Intermediate-term Municipal Income fund had a loss of 1.11% for the month. The duration of the Intermediate Municipal Fund on the HKFS/SEI
platform was reported at 5.5 years as of February.
The Investment Advisory Committee reviewed model bond funds currently on ‘watch’ status.
The following bond funds are on ‘watch list’ status:
Name
BlackRock GNMA
Reason
Std. Deviation, 12-mo Return
Current Status
Hold
BlackRock GNMA: (added to watch list 12/19/13)
The BlackRock GNMA Bond Fund is on the watch list due to higher standard deviation vs. its
benchmark index and due to 12-mo. underperformance vs. its benchmark. It has a standard
deviation of 2.92 vs. 2.58 for the BarCap GNMA index. BGPSX has performed in the top
HKFS Investment Advisory Committee Summary, March 30th, 2015
5
Internal Use Only, Not to be Distributed to the Public
50% of its competitors over the past 3 and 5-year periods of time. BGPSX has outperformed
over the past 3 years annualized at 2.10% (data through 2/28/15).
Recommendation: Hold; the Committee has reviewed other alternatives to lower expense
drag, however, found no appropriate substitutes.
INVESTMENT OPERATION ISSUES:
The Committee reviewed the monthly list of households over $1 million. All non-model
account households over $1 million are reviewed annually by the Committee. All households
under $1 million are reviewed annually by the HKFS CIO and the HKFS Senior Trader.
Accounts are analyzed for non-compliance under the following criteria: actual allocation vs.
target allocation with more than a 5% drift from the target, individual stock or bond
positions that represent more than 10% of the household assets, and cash positions above
10%. In addition, accounts with individual bond or stock positions that are inconsistent with
current policies are noted, with follow-up with advisors mandated.
For the month of March, the Committee reviewed 36 client households, representing 150
accounts. There were 31 occurrences outside current HKFS policies that will require followup with the advisor by the HKFS investment team.
This month, 127 non-model accounts under $1mm that had no trade triggering activity
(such as income or principal deposits, distributions, or maturities) were reviewed by the CIO
and Senior Trader. Advisors have been contacted with rebalancing recommendations.
The Committee discussed transition of our models from the Schwab rebalancing software to
the new Orion/TrX software. There are some additional complexities involved with this
software, which will require the creation and continued maintenance of numerous models
combining the growth, equity income, income and SHO models at various levels of
allocation. The addition of ETF models at numerous allocations would add a significant
additional number of models to maintain, which are not being used to any great degree by
FAs (currently only 47 accounts are using ETF models). Additionally, using ETFs for some
bond sectors is not in the best interest of our clients due to the illiquid nature of bond
markets. After discussion, the Committee agreed to limit support of ETF models to accounts
using select allocations to growth or equity income. Current modeled accounts using these
strategies are encouraged to transition to other models but will not be required to change at
this time. All bond ETF models will be permanently discontinued.
Assets Under Management ($ thousands):
2/28/15
1/31/15
Schwab (billable)
$ 1,758,209 $ 1,705,558
SEI (billable)
$
68,598 $
66,586
Other (NT, Wells, etc.) $
33,405 $
31,717
NextStep
$
28,753 $
27,665
HKFS RPS
$
337,684 $
307,215
Total
$ 2,226,649
$ 2,138,741
12/31/14
$ 1,685,377
$
67,037
$
31,542
$
27,908
$
307,249
$ 2,119,113
2/28/14
$ 1,435,507
$
62,918
$
29,130
$
28,365
$
245,673
$ 1,801,593
The next Investment Advisory Committee meeting is scheduled for Wednesday,
April 15th at 10:00am.
HKFS Investment Advisory Committee Summary, March 30th, 2015
6