Over the past 6 months, markets have witnessed significant divergence across geographies, sectors and asset classes. From June to December, foreign stocks have substantially underperformed domestic stocks as foreign currencies experienced substantial depreciation relative to the U.S. dollar. The Euro has fallen 9%; the British Pound, 7%; and the Japanese Yen, 13%. These foreign exchange losses drove significant underperformance of equity markets in the relevant geographies. For example, the MSCI Europe Index underperformed the S&P 500 Index by almost 19.0%.
The most striking development over this time period has been the collapse in global oil prices, with crude oil declining 47%. This has led to significant declines in the prices of equity and debt instruments tied to the oil sector.
The high yield asset class also suffered declines in the second half of this year falling 2.6%. A modest widening in high yield spreads during the third quarter picked up steam in the fourth quarter, as pronounced declines in many energy bonds spilled over into the asset class more broadly.
The NAV of First Eagle Global Income Builder’s class A shares (without sales charge) was impacted by these factors and has declined roughly 5.5% from June 1, 2014 to December 19, 2014. The Fund’s equities were the largest detractor, driven by our exposure to Europe and our energy holdings. Our credit portfolio has also delivered negative returns, as the yields available from high yield bonds increased.
These declines in European stocks, energy stocks and credit were somewhat mitigated by generally stable or positive performance from our investments in U.S. equities, Asian equities, currency hedges and cash and cash equivalents.
Given the recent volatility, we continue to review our sense of the intrinsic value of the securities in our portfolio and reposition as the situation warrants. We believe that the decline in the energy sector has created potential buying opportunities on both the equity and credit side, but we would caution against expecting oil prices to quickly return to prior levels. We believe that in the short-term, the oil market is oversupplied, but over the long-term a reduction in investment may sow the seeds for the next spike in crude prices. Despite the recent decline, we continue to believe that energy is an important component of our portfolio.
The volatility in European markets has in some cases created an attractive buying opportunity for high quality, global businesses that are domiciled in Europe. During this period, we have established new positions, or added capital to existing holdings, in such businesses at prices we consider quite favorable.
High yield has faced significant outflows, generally forcing ETFs and investment managers to sell both energy and non-energy bonds to meet redemptions. As a result, many higher quality, liquid issues have declined, creating an interesting opportunity to selectively allocate to the asset class. We view the significant underperformance of non-energy domestic high yield bonds relative to domestic equities as potentially signaling a value opportunity. We have added capital to the asset class in an attempt to take advantage of the dislocation, while revisiting existing investments in light of new economic realities.
Since the inception of the Fund, we have been generally averse to investing in duration amidst historically low interest rates and global quantitative easing. We believe this continues to be the correct approach over the medium-to-long-term. Recently, however, it is clear that the renewed onset of deflation as well as geopolitical events, such as the Russian currency crisis, have made duration an attractive place to hide. High dividend sectors of the U.S. stock market such as REITs and regulated utilities generally have significant duration exposure, and our avoidance of these sectors has contributed to our lower allocation to the U.S. equity market. We remain concerned that stock prices in these sectors, which are at historically high multiples, are unattractive. With 10-year treasury yields close to 2%, we continue to see duration as a poor risk/reward opportunity for long-term investors seeking to compound their wealth.
This recent period of volatile performance is perhaps a good time to remind investors that we practice a benchmark-agnostic approach. Our absolute return-oriented, bottom-up investment process may lead to outcomes that are at times meaningfully uncorrelated with commonly used equity and bond market indices. In periods where domestic equity indices in particular deliver significant outperformance, investors in the Global Income Builder Fund should be prepared for some degree of underperformance relative to standard benchmarks. Most passive investment strategies and many actively managed investment strategies tend to exhibit a high degree of correlation with conventional equity and bond indices (and, in fact, are intended to do so). Furthermore, such strategies often play a core role in the portfolios of individual investors. We believe investors should consider that the eclectic mix of investments contained in funds like the Global Income Builder potentially offers access to opportunities not usually available through benchmark-oriented approaches, as well as diversification benefits.
We appreciate your confidence and thank you for your support. Sincerely,
First Eagle Investment Management, LLC
