We killed our quarterly newsletter in 2019 largely because there is not much to report on in most quarters and we do not want to wait until quarter-end to share when something newsworthy does occur. So we have moved most of our public writing and updates to our blog, but we do want to continue the tradition of an annual letter to reflect on the year, share firm updates, as well as express our deep thanks.
Nearly every asset class posted phenomenal returns in 2019, although this was certainly not the consensus expectation in late 2018. By December 2018, the Federal Reserve had raised rates four times in the calendar year, the consensus was that long-term rates were headed higher and that bonds would get crushed. More than a few people asked if they should move their fixed-income allocation to cash. In Q4 2018, the S&P 500 index declined 20% peak-to-trough, trade tensions were rising, and the media was warning of a recession. Yet rates did not continue higher; they peaked in November 2018 and the Bloomberg Barclays Aggregate Index returned 8.57% in 2019. Similarly, the US did not fall into a recession and the S&P 500 returned over 30% in 2019. How could 2019 turn out so differently from what people expected in 2018?
There are many possible explanations, but I believe many of them relate to the cognitive biases that we humans have: we are emotional, we overweight available evidence (especially if it confirms our beliefs), we overweight recent events and experiences, and we often apply narratives where none exist (and even project these narratives into the future). Investors can combat these issues to an extent by objectively weighing evidence and considering the future as a range of possible futures. For instance, we did not know where rates were headed in 2019, but we were not convinced that short- or long-term rates would continue higher. In fact, there was a lot of evidence that long-term rates could decline based on how flat the yield curve was. We made several moves in Q4 2018 to express this view. In terms of an impending recession, we just could not find evidence of one. I recall combing through all of the data and indicators that we monitor to find what we were missing and to build a case for a recession, but the weight of the evidence simply did not support it. And without a recession, we thought a major equity market meltdown was extremely unlikely. Furthermore, if there was no recession on the horizon, we thought that equity market declines were likely overdone. We emailed a note to clients on December 24, 2018 and the closing lines were: "Markets go up and down and nobody knows where they are headed in the coming days and weeks, but history has shown that declines of the current magnitude are often followed by very strong performance. Not always, but more often than not. We believe investors will be rewarded for staying the course and that now may even be a good entry point for additional capital."
Looking ahead, we expect an interesting year. Some investors think financial markets are euphoric and are ripe for major declines, while others think the good times will continue to roll. We have views on some asset classes (or specific segments of asset classes), but we can also envision many possible ways that the year and decade could unfold and are positioned accordingly. While we are not at liberty to discuss specific investments and/or performance publicly (nor would we as our clients' allocations are diverse and very little commentary would be relevant to every MFA client), we do encourage clients to discuss their portfolio, holdings, and strategy with their advisor. In addition to market and portfolio updates, we do have quite a few firm updates.
We Moved (Twice!)
In January 2019, we opened a second office in Fremont and migrated our investment and operations teams to the new location (while our advisory team operates out of both SF and Fremont). In addition to meeting the needs of our clients in the South Bay and East Bay, the Fremont location provides the ability to hire quality talent in the area and we were thrilled to add two members to our advisory team this year. In December 2019, we moved our SF office to the 35th floor of 44 Montgomery (same building, different floor). The moves went as smoothly as we could have hoped and we believe our new offices will allow us to better serve our clients.
2019 was a landmark year for trading costs as many of the major brokers and custodians cut their trading fees to $0. A major consequence of this change is that Separately Managed Accounts (SMAs) are now a much more compelling option for a larger segment of investors (who have historically been limited to mutual funds and ETFs for low-cost equity exposure). Prior to 2019, MFA had recommended "direct indexing" (buying the individual stocks underlying an index, as opposed to buying an index fund) to some clients, but the strategy was reserved for larger equity allocations. Now that trading costs have disappeared, we can offer this service to many more clients. Despite the increased competitiveness of SMAs, we remain agnostic towards investment vehicles and will recommend mutual funds, ETFs, and/or SMAs based on individual client situations.
Real estate continues to be one of the best asset classes to preserve and grow wealth. While American real estate has historically received generous tax treatment from the IRS, the 2017 Tax Cut and Jobs Act compounded this even further. Thus, many of the managers that we work with made structural changes in 2018 and we began to realize more of those tax benefits in 2019. Given the well-known benefits of real estate, it is a bit surprising that we continue to find attractive opportunities in real estate. We spent a huge amount of time this year sourcing additional real estate managers. While it is long process to find managers and understand their strategy, independently verify the information that they provide, interview service providers and references, order background checks, cross-check property data on county websites, and so on, we are happy to report that we have added two real estate equity funds and two real estate debt funds to our alternative investment platform in 2019.
Although the aforementioned 2017 TCJA created "opportunity zones" and "qualified opportunity funds" two years ago, scant guidance from the Treasury and IRS prevented many strategies from launching. That changed in 2019 as the Treasury and IRS issued definitive guidance, which allowed dozens (if not hundreds) of funds to effectively launch. We looked at a lot of qualified opportunity funds and only found one that we are willing to recommend thus far. Again, it was a long process, but we are happy to have one and excited to help our clients reap the social and tax benefits of investing in distressed communities.
A Focus on Quality
Although we aggressively expanded our capabilities and our assets under management increased by approximately $50 million in 2019, we remain committed to serving our existing clients well. In fact, we could have grown even more, but we turned away more prospective clients in 2019 than ever before. Our priority is to serve our clients well and continually improve our service offering; we are focused on growth too, but only to the extent that we are able to maintain the quality of our service. Thank you to all the clients who participated in our client survey this year; we received valuable feedback, are busy implementing the action items that came from that, and hope to see improvements reflected in our clients' experience moving forward.
Thank you to all of our clients, both those that have been with us for the entire decade and those that joined us in the past year. We are deeply appreciative of the trust you've placed in our team and we take our responsibilities to you very seriously. We also appreciate the friends and family that you've sent our way and will do our best to serve them well. We're looking forward to both 2020 and the 2020s.