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The Second Quarter of 2014 in Review

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In the second quarter of 2014, market risk was rewarded around the world, particularly for emerging markets and real estate. Portfolios tilted towards small cap companies were not rewarded to the same extent as portfolios tilted towards large caps companies. On June 18th, the Federal Reserve announced that it would cut its monthly asset purchases by $10 billion, thus continuing its expected tapering of Quantitative Easing. The bond market definitely appears to be OK with this, as the 10-Year Treasury yield is now 0.2% lower than it was at the beginning of the quarter (2.5% vs. 2.7%). On the international front, the biggest story was the terrorist group formerly known as the Islamic State of Iraq and the Levant (ISIL) taking over a large section of Iraq, including its second largest city of Mosul. On June 29th, they changed their name to simply “Islamic State” and declared the re-establishment of the Islamic Caliphate (a super-state that would transcend all borders between existing Islamic countries). Although President Obama has promised that America will not return to Iraq, the extent of our commitment to the Iraqi government appears to be growing on a daily basis. Naturally, in its usual response to increasing instability in the Middle East, the price of oil went up by about 5% during the quarter, and as of today (7/1/2014), it remains above $105 per barrel.

Domestic Equities

For the different sizes and styles of domestic equities, the quarterly returns ranged from 2.24% for small cap to 6.16% for large growth. The clear pattern is that large caps beat small caps.

For the blend of domestic equity indexes used in the new IFA Index Portfolios, the quarterly return was 3.77% which lagged the 4.86% return of the overall market. On a year-to-date basis, the return of the IFA blend was 5.40% vs. 6.99% for the overall market.

International (Developed) Equities

On the international front, while small caps dominated large caps in the first quarter, they switched places in the second quarter. On a year-to-date basis, small caps remain ahead.

For the blend of international indexes used in the new IFA Index Portfolios, the quarterly return was 2.85%, and the year-to-date return was 6.73%.

Emerging Markets

After a weak first quarter, the second quarter emerged as a strong one for emerging markets across the board, although tensions continue between Russia and Ukraine, and China continues to re-assert its claims over islands currently governed by Japan.

For the blend of emerging markets used in the new IFA Index Portfolios, the quarterly return was 7.06%, and the year-to-date return was 8.14%.

Real Estate

Real estate followed a strong first quarter with an even stronger second quarter. Again, there was no single news story that appeared to explain it. The IFA Real Estate Index delivered a quarterly return of 7.99% and a year-to-date return of 16.18%. This index is a blend of domestic real estate which returned 7.18% for the quarter and international real estate which returned 9.60%.

Fixed Income

Given that there were no significant surprises from the Fed, fixed income held steady, delivering a positive return for the quarter.

For the blend of fixed income used in the IFA Index Portfolios, the quarterly return was 0.46%, and the year-to-date return was 0.82%. Once again, it is important to note that bond yields remain at low levels relative to their historical averages.

IFA Index Portfolios

Putting it all together, the returns of the IFA Index Portfolios are shown below, net of one quarter’s worth of IFA’s maximum annual 0.90% advisory fee for the quarterly numbers and two quarter’s worth for the year-to-date numbers.

Results not yet finalized

One important thing to keep in mind when reading these quarterly reviews is that one quarter (or even one year) is absolutely meaningless in determining overall relative performance among asset classes or portfolios consisting of those asset classes. The two charts below show how the probabilities (based on historical returns data) drastically change as the time period increases.