2nd quarter Kildare performance letter

A common investment debate involves buy and hold vs. active management.  The buy and hold approach believes in investing for the long term while active management attempts to adjust positions according to various market conditions.  In a strange set of events, 2016 had something for both sides.  The year began with a gut wrenching drop, then a recovery, and finished the first six months with historic strength.  So rewards came to the properly timed trader as well as the investor who rode out the volatility.  This hindsight makes it sound simple, but neither strategy was easy to execute.
2016 started with the worst stock market decline ever to start a year.  By mid-February the Dow Jones Industrial Average and the S&P 500 had fallen by over 11%.  The Nasdaq and Russell were each down over 16%.  A partial list of investor anxiety included the impact of falling crude oil, weakening emerging markets, and U.S. interest rate increases.
The markets bottomed in February and then recovered the losses by mid-April.  From there markets treaded water until the Brexit vote in late June.  The unexpected vote to ‘Exit” caught the markets off guard and global stock markets fell.  But after only two days, stocks stopped the decline and, amazingly, reversed course.  The bounce quickly gained momentum and turned out be to a historic move.  The S&P 500’s last three days of June were gains of 1.78%, 1.7% and 1.36%.  This better than 4.5% spike was the third strongest end to a first half of the year for the S&P and the strongest since 1962!  This helped return three of the major averages to the plus side for the six months.
At the end of June here are the returns for the major averages:
Dow Jones Industrial Average  +2.9%
S&P 500                                    +2.7%
Nasdaq Composite                    -3.3%
Russell 2000                             +1.4%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
Someone looking only at the six month numbers, like a ‘buy and hold investor’, would conclude not much happened other than a small advance for most averages.  An active investor might be equally satisfied if they were able to navigate 2016’s volatility.  The reality is that it is difficult to time the markets on a short term basis so there are likely some active investors who underperformed a buy and hold approach.  That’s not to anoint the buy and holders as there were several ‘long term’ investors who could not take the pain that the markets were piling on.  They sold positions into February and missed out on the rebound.  Further, it seemed that both sides were selling into the Brexit result.
Client’s accounts followed a mix of some long term core positions as well as some adjustments that helped to stabilize returns and reduce risk.
One of the strategies that contributed to client accounts’ success in 2016 has been positions in closed end funds focusing on high yield corporate bonds, corporate loans, and taxable municipal bonds.  This asset class (high yield corporate debt) was a big loser in 2015 as these bonds were widely used to finance oil and gas exploration and production.  The drop in the price of crude oil increased concerns that the bond issuers might not be able to pay off these bonds.
However, the selling of the energy bonds caused weakness across all of the high yield sector.  While the energy related bonds did have increased risk, the widespread selling resulted in good opportunities in bonds from other industries.  Further investing in this debt through closed end funds presented enhanced value as many of the funds were selling at significant discounts to their net asset value.  This offered a compelling margin of safety.
After the markets bottomed and the economy offered signs of stabilizing, these bonds increased in price.  The closed end funds appreciated along with the underlying bonds.  These higher prices together with the 6 – 8% yields offered solid double digit total returns in the first half of 2016.
When choosing the funds, I focused on ones that did not have exposure to the energy sector.  Some that I used are Blackstone Strategic Credit Fund (BGB), Blackstone Floating Rate Fund (BSL), Blackstone Taxable Municipal Bond Trust, and the Eaton Vance Senior Income Trust (EVF).  We sold the Deutsche High Income Trust (KHI) after the price appreciation moved the fund up to a slightly overvalued level.
Looking towards the second half of 2016, both ‘buy and hold’ and ‘active investors’ are facing high levels of uncertainty.  Geopolitical conflict, terrorism, Brexit, negative interest rates, and a polarizing U.S. presidential election are just a partial list of unknowns facing the markets.
I think the post-Brexit move in the stock market (as hard as it is to explain) is significant.  And U.S. stocks have added to this move in July.   As mentioned above, stocks ended June with the third strongest three-day performance ever.  In the two other examples as well as the fourth best (1999), the S&P 500’s median gain in the second half of the year was 7.03%.  Admittedly, this is a pretty small sample but it is something to keep in mind.  I will continue to look for the opportunities that offer favorable risk and return situations throughout the next six months and beyond.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional
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