SEI Growth-Focused Strategic Portfolios

Brexit dominates headlines in Q2 2016; fixed income rallied while global equity markets stabilised after initial shock of a ‘leave’ vote

• Following the relative calm of April and May, June ended raucously as markets digested the at least partially unexpected outcome of the UK EU referendum vote. Fixed income yields fell in a ‘flight to safety’ response from investors, while equity markets initially declined modestly and then rallied on the expectation of central bank support.
• Overall, the SEI Strategic Portfolios delivered strong absolute returns across the range, beating broad market indexes over the quarter*. UK investors with globally diversified investment strategies, such as those inherent to the SEI Strategic Portfolios, generally benefitted from the decline in sterling, as the value of unhedged non-sterling holdings in equities appreciated in GBP terms.
• Within the Growth-Focused SEI Strategic Portfolios (the Core, Balanced, Growth, and Aggressive Funds), Global diversification and asset allocation were key contributors to positive returns over the period. Strategic allocations to European small caps detracted, while the allocations to US small caps and emerging markets supported returns. Looking within the traditional equity asset classes, the recent rotation into valuation-focused strategies detracted from relative returns as investors fled to the defensive sectors, despite their already substantially rich valuations.
• SEI is likely to largely hold the line on the bias towards valuation-oriented strategies and the defensive sectors look very expensive compared to history and when the fear subsides, investors are likely to re-focus on valuation. Markets have tended to revert to the mean and there is no strong reason this should be different this time around. Patience and discipline are critical to investment success and are often most tested at times of crisis.
• Commodities asset class: Commodities as a whole performed well for the quarter. Oil performance was very positive as supply outages in Canada, Nigeria and Libya aided returns.  Soybean returns were also strong, driven by poor weather in key South American growing regions. Active positioning in base metals and grains benefitted the fund on a relative basis while energy positioning modestly detracted.

Market Overview

• The second quarter’s most prominent event, a vote by UK citizens in favour of leaving the European Union (EU), took place with roughly a week left in June. Market volatility had increased markedly ahead of the referendum, but not by enough to compensate for the unexpected outcome, as polls and bookmakers, while split, generally projected a victory for the Remain campaign.
• A sharp spike in global stock-market volatility ensued; yields were driven downward to record levels on perceived safe-haven investments like developed-market government bonds, and sterling and the euro, the currencies at the centre of the developments, weakened substantially relative to the US dollar and Japanese yen. Much of the stock-market losses were recovered within a week’s time, suggesting the impending multi-year uncertainty may not be as detrimental to global economic health as initial reactions implied.
• The preceding 11 weeks of the quarter were largely uneventful and major central-bank policies were essentially on hold through April and May. The ECB commenced two stimulus measures in early June that been announced in March: corporate-bond purchases and targeted long-term repo operations. Oil prices advanced for much of the quarter then levelled off in June as OPEC failed again to agree on a production freeze, while the yen strengthened relatively steadily against most other major currencies.
• In terms of economic data, US manufacturing growth accelerated to healthier levels in June, with new orders a key source of strength. Labour productivity dropped by 0.6% in the first quarter but year-over-year productivity advanced by 0.7% as output gained by more than hours worked, suggesting seasonality might have contributed to weakness.
• Eurozone services sector growth softened modestly in June, while an increase in manufacturing growth compensated, keeping the composite level mostly steady going back to February. Producer prices jumped 0.6% in May, more than offsetting April’s decline, but still deeply negative year over year. Eurozone unemployment remained high in May, declining by 0.1% to 10.1%. However, a 1% drop from a year earlier demonstrates some improvement in the labour market. First quarter economic growth for the EU was revised upward, to 0.6% and 1.7% year over year.
• UK construction activity contracted with some intensity during June, its first decline since early 2013. Services sector activity decelerated to its slowest level in more than three years, albeit still in growth territory. A final reading of economic growth registered 0.4% for the first quarter and 2.0% year over year. Looking forward, clearly much will depend on the effect of the Brexit vote on consumer confidence and business investment.

Selected Asset Class Commentary

• Global Credit Fixed Interest asset class: Global corporate bonds performed well in the aftermath of the Brexit vote which drove yields lower. The duration and yield-curve positioning of the fund were largely neutral in terms of their contribution to relative performance. An overweight to corporate credit, particularly US corporates, contributed, as did off-benchmark high-yield exposure. Active currency positioning, mostly in the form of an underweight to the euro, was also positive. With the exception of JP Morgan Investment Management, all asset class managers outperformed during the quarter.
• Emerging Markets Fixed Interest asset class: Local currency bonds from emerging-Europe countries struggled in the post-Brexit landscape; meanwhile, US dollar-denominated issuers, commodity exporting countries and other regions, such as Latin America, performed well. Stone Harbor Investment Partners contributed as an underweight to Hungarian local debt and overweight to Venezuelan debt helped relative performance. The fund is neutral weight in local currency debt. An underweight to external debt remains; however, this is in conjunction with an overweight to corporate bonds. The higher yields and lower interest rate sensitivity of corporates are attractive. The remaining allocation is a modest exposure to cash.
• UK Equity asset class: UK equities fell sharply after the Brexit results were revealed, but quickly recouped a significant portion of the losses and actually finished the quarter positive in local currency terms. In US dollar terms however, results were negative as sterling fell to 30-year lows against the greenback. The weakening currency was actually positive for export-oriented mega-cap companies while mid-sized companies, especially those more exposed to UK consumers were still showing steep losses at the end of the quarter. Los Angeles Capital Management’s trend-following, momentum approach was caught wrong-footed with both a structural underweight to mega-caps and a more domestic orientation. Jupiter Asset Management, while still marginally underperforming, benefitted from its naturally more defensive orientation.
• Europe Equity asset class: The continent actually suffered more than the UK as a result of Brexit. The euro held up better than sterling, thus European multi-national companies did not receive the same benefits from currency moves as their UK counterparts. Further, nervous investors de-risked which had a disproportionate impact on peripheral markets. The fund struggled in a difficult environment that punished its pro-cyclical sector positioning and underweight to defensive sectors. At the manager level, unsurprisingly Wellington performed well in a "risk-off" environment through an emphasis on high-quality businesses. Conversely, value manager METROPOLE Gestion underperformed due to overweight positions in Ireland and Italy.
• Emerging Markets Equity asset class: Emerging Europe struggled due to Brexit while Latin America benefitted from the continuation of a rally in commodity prices and relative currency strength. This was a challenging environment, but one in which most of the fund’s managers generally performed well. Neuberger Berman produced the strongest results, with contributions from Korea, Taiwan and China. RWC Asset Advisor’s strategy continued to perform well courtesy of positive results in Latin America, especially Brazil and Argentina, and in EMEA where they have exposure to Russia, one of the few countries in the region to post gains. The fund’s largest underweight remains financials, in particular the banking segment which is primarily driven by an underweight to the Chinese banking stocks on the basis on ongoing worries about a Chinese credit crisis.

Manager Changes

• Principal Global Investors has been added as at 16 June 2016 to the investment used to access the Pacific Basin (ex-Japan) equity asset class as a replacement for temporary passive manager SSgA. Principal maintains that the majority of investors are averse to risk and to change, creating persistent biases, anomalies and inefficiencies upon which it can capitalise. Its investment management team seeks to generate alpha through early identification of fundamental changes (relative to market expectations) while avoiding overpaying for such changes.

Outlook

• UK’s vote to leave the EU is a major political and economic event that will likely weigh on international financial markets, not just for weeks and months, but perhaps for years. The leap into the unknown will likely depress UK economic growth as business spending gets frozen until some clarity re-emerges on the country’s trading relationships. Sterling’s plunge immediately following the Leave voteshould provide a much-needed offset to the mostly negative impact of all the uncertainty, as UK exporters find themselves in a more competitive position.
• Britain’s growth prospects were decent prior to Brexit; by contrast, continental Europe was already struggling to improve. Of the many economic imbalances that exist in the world, among the greatest is the huge trade surplus run by the eurozone. In the aftermath of the Leave vote, nationalist parties in various countries are lobbying for their own referendums on continued membership in the EU, which adds to the uncertainty facing investors. The fragility of the eurozone recovery going into this crisis is a matter of concern. The fact that bond yields did not bounce higher even as stock prices rallied post-Brexit is a divergence worth noting.
• SEI believes that the US remains the cleanest shirt in the laundry bag, staying resilient despite numerous shocks over the past seven years. This puts the Federal Reserve in something of a quandary, since the Brexit shock has seemingly upended any possibility of a near-term rise in the funds rate. Market-implied expectations for the next policy-rate move have been pushed out to late-2017; in fact, futures traders have priced in the mild possibility of a rate cut in the near term.
• However, there is a growing sense of that the U.S. central bank may be a falling behind the inflation curve. Soggy global economic growth and the shock delivered by the UK vote argue for a very cautious process of interest-rate normalization. But if the upward trend in labour costs is sustained, a more aggressive response by the US central bank eventually will be justified. In the months immediately ahead, investors’ attention mostly will be focused on the US presidential election. Like recent and upcoming contests in Europe and elsewhere, the US contest will contentious.
• Globally, the points of general consistency in SEI’s investment outlook and positioning are that their fixed-income managers generally favour credit at the expense of interest-rate duration, and that defensive and momentum-focused strategies appear quite expensive within equities. Politics is a difficult game to predict, but its importance should not be overemphasised. SEI expects challenges for the UK and eurozone economies and their currencies, but a repeat of the 2008 global financial crisis appears improbable.
• Investors are likely to re-focus on valuations once the fears subside. Given this view, SEI believes the continuing emphasis on valuation-focused strategies over those with a defensively-orientation in most developed markets is warranted. During the times of greatest uncertainty, sticking to an investment plan and philosophy can seem like the hardest thing to do; SEI and the managers intend to do so and would strongly suggest that where possible investors to continue to take a similar approach.

Important Information on Performance

Past Performance is not a guarantee of future performance. Standardised performance is available upon request. All data is as at 30 June 2016.

Asset class performance discussed is based on the majority SEI fund underlying the asset class. This does not include analysis of the manager pools, hedged share class investments within SEI Funds, additional SEI funds or any third-party funds within the Strategic Portfolios. As a result, performance for the total asset class allocation may vary. Not all asset classes discussed are included in all Strategic Portfolios. All asset class comparative performance is relative to the benchmark of the specific SEI fund representing the majority of the asset class investment.

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The SEI Strategic Portfolios are a series of the SEI Funds and may invest in a combination of other SEI and Third-Party Funds as well as in additional manager pools based on asset classes. These manager pools are pools of assets from the respective Strategic Portfolio separately managed by Portfolio Managers which are monitored by SEI. One cannot directly invest in these manager pools.

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This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

Investments in SEI Funds are generally medium- to long-term investments. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. The risks described below may apply to the underlying assets of the products into which the Strategic Portfolios invest:

• Investment in equity securities in general are subject to market risks that may cause their prices to fluctuate over time.
• Fixed income securities are subject to credit risk and may also be subject to price volatility and may be sensitive to interest rate fluctuations.
• Absolute return investments utilise aggressive investment techniques which may increase the volatility of returns. If the correlation between absolute return investments and other asset classes within the fund increases, absolute return investments’ expected diversification benefits may be decreased.
• International investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations.

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SEI sources data directly from FactSet, Lipper, and BlackRock, unless otherwise stated.