Our CEO’s Q3 2023 Letter to Clients
November 7, 2023 Third Quarter
We cannot begin a discussion of this quarter without acknowledging the tragedies taking place in Israel and Palestine, and increasingly across the world amid rising antisemitic and anti-Palestinian rhetoric and violence. Despite our years of work in human rights, seeing the way this crisis has unfolded is shocking. How do we begin to understand the loss of life? How do we begin to make sense of the permanent scars this will leave on those affected, both on the ground and afar? What will it mean and require for the thousands displaced to restart their lives?
Amid an issue as complex, historical, and deeply personal as this one, we are further than ever from understanding the right thing to say or do. One thing is clear: the attack on innocent people is never acceptable.
Given that so much of the situation is ongoing, it feels premature to even look forward while we are still in the midst.
Update on Economic Outlook and NorthStar’s Strategy
Higher for Longer Interest Rates
We usually lead with a discussion of equity markets, but, since early 2022, it has been the bond markets that have been driving returns across all other asset classes. This quarter was no exception, as both equity and bond markets finally began to accept the reality that the Federal Reserve Bank is intent on keeping its key Federal Funds Rate relatively high until the 2% inflation target is achieved. In conjunction, the yield on the 10-year US government bond increased by 83 basis points from 3.84% to 4.57%. There are many potential explanations for the increase in long-term yields: rising government deficits, resilient economic growth, reductions in purchases of US government debt by the Federal Reserve Bank and foreign central banks, unexpected supply shocks, or a confluence of all these factors. Nevertheless, we remain of the view that the recent 12 years2 of near-zero short-term interest rates were an anomaly and that we have begun a long-term normalization cycle. We believe there is a high probability that interest rates will remain at these or higher levels over the mid-to-long term, as our government and others will need to fund Social Security, Medicare, and Defense programs while grappling with challenges related to ecological limits and socio-political upheaval.
As we have discussed in past letters, we remain convinced that the world remains severely imbalanced as it struggles to address complex interrelated societal, geopolitical and ecological challenges. As a result, we anticipate continued elevated volatility and uncertainty in financial markets going forward.
Adding higher yielding bonds to portfolios
So, how do we navigate the high degree of uncertainty in the financial markets? First and foremost, by ensuring we understand your financial needs and objectives and having an appropriate target asset allocation and liquid reserves. Since 1980, interest rates have declined, but now that cycle is reversing. This may pose a headwind for the equity returns we have become accustomed to, but it also provides an opportunity to earn higher 5-6% interest rates in bond portfolios. Therefore, where appropriate, we are adding government bonds in the 1-5 year maturity range to our clients’ portfolios. We believe that bonds in this maturity range offer an optimal combination of flexibility, higher income returns, and stability for the portfolio.
High quality stocks with low debt can still provide long-term growth.
It is not all doom and gloom for equities, though. We have often commented on the futility of short-term forecasts, and that remains the case. However, over the mid-long term, companies with low financial debt and that make products or sell services that are beneficial to human life and that solve or mitigate some of the most pervasive problems of our time should continue to thrive. We continue to own and add stocks of companies with these types of business models to equity portfolios. To manage risk, we follow our systematic quarterly rebalancing strategy in which we trim individual stocks that are well past their target weights and reallocate to stocks that are under their target levels.
Negative returns for both Equity and Fixed Income portfolios
The steepening of the yield curve (longer maturity yields increased by more than on the short term) led to steeper declines in the prices of bonds with longer maturities. Our fixed income portfolio underperformed the short-term benchmark as it holds longer maturity securities. This is primarily related to the benchmark mismatch issue, and we will be moving to a more appropriate benchmark in 2024. Compared to benchmarks4 with similar maturities to our portfolio, the NorthStar fixed income portion outperformed.
Government Bond Yields (in percentage)
|Jan 31, 2023
|Mar 31, 2023
|Jun 30, 2023
|Sep 29, 2023
|US Govt 2 Year
|US Govt 10 Year
Source: Bloomberg, October 6, 2023
The equity portions of NorthStar clients’ portfolios underperformed our equity benchmark (70% S&P 1500 and 30% MSCI EAFE) for the quarter. The sudden rise in bond yields triggered an immediate sell-off in stocks, resulting in a quarterly return of -4.8% for the S&P 500 and -5.8% for the NASDAQ index. Most sectors had negative returns for the quarter. Oil companies in the energy sector had the highest positive returns as the price of oil spiked on news of low inventories and production cuts from Russia and Saudi Arabia. Traditional financials also eked out a positive return. As we don’t own these companies, it hurt our relative performance. Stock specific issues for a few of our holdings also detracted from quarterly returns.
Yes, summer has ended, but there is something about Fall that feels like a new beginning. Shifts in the weather, forage, and light patterns encourage us to pause, reflect, and consider new ideas and intentions. For Outside Investments, this shows up as completion of our spring and summer annual reviews of existing Outside Investments and our exploration of new organizations.
It is from this place that we’re excited to introduce you to Genesis Fund – a Maine based community development financial institution (CDFI) that we are now recommending. Genesis provides flexible, affordable financing and technical assistance to local Maine nonprofits focused on preserving and creating affordable housing. These nonprofits often face challenges in accessing appropriate capital and expertise for pursuing projects that are often complicated, time intensive, and regulatorily complex. Yet affordable housing isa critical, yet out of reach resource, for too many families, which makes Genesis’ enduring commitment and deep expertise critical.
In addition to Genesis’ focus on housing, we have been especially impressed with their commitment to racial equity. There has been an influx of immigrants to Maine, particularly immigrants of African descent, and Genesis Fund has been at the forefront of providing this community with essential services and infrastructure.
We are glad to have connected with Genesis Fund over the past few years, and we look forward to introducing you to them. In the meantime, please let us know if you are interested in Genesis Fund, and we can have a conversation about how it might fit within your portfolio. You can find additional information on their work by visiting their website: https://genesisfund.org/.
Shareholder Activism Update
We are proud to share that our 2022-2023 Social Change & Activism Annual Report (“the Activism Report”) has been published to our website. Reporting on the 2022 year of NorthStar’s shareholder activism and proxy voting, this document shares our current approach to some of the pressing issues of our time such as systemic racism in corporate culture, lagging diversity on the board of directors, and the erosion of human rights in the corporate supply chain. In our report, we detail outcomes of these efforts, including a fruitful engagement with PayPal on issues of racism and inequitable employment outcomes for people of color in its workforce. During that engagement, PayPal demonstrated the concrete steps it is taking to identify and dismantle structural racism that permeates corporate culture, allowing us to withdraw our proposal after successful dialogue. Additionally, we are pleased to report continued strong support for our equal voting proposals at companies where founders own shares with outsized voting rights and can outvote ordinary shareholders on matters of critical importance, indicating that shareholders at large agree that ordinary shareholders need a way to hold company management accountable.
Also in our Activism Report, you will find summaries of how we voted your proxies during the reporting year. In 2022 overall, we typically voted opposite of company management’s preferred voting outcomes (on 78% of proxy items). This means that we supported most (96%) shareholder proposals, against nearly all (99.9%) executive compensation packages, and continued to take a skeptical stance towards rote proxy items (like auditor elections) that may seem mundane but can have great significance. In our quarterly video that accompanies this letter, you will see two of NorthStar’s staff – Whitney Nguyen, Director of Impact Research, and Alexandra Dorfman, Client Service Associate – discuss more details of our 2022 Activism Report and our achievements for the year.
Julie N.W. Goodridge Nimrit Kang
Founder & CEO Chief Investment Officer
The forecasts, opinions, and estimates expressed in this report constitute our judgment as of the date of this letter and are subject to change without notice based on market, economic, and other conditions. The assumptions underlying these forecasts concern future events over which we have no control and may turn out to be materially different from actual experience. All data contained in this letter is from sources deemed to be reliable but cannot be guaranteed as to accuracy or completeness. All investments are subject to risk, including loss of principal. Past performance is no guarantee of future results. It is not possible to invest directly in an index.
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This information includes a discussion of a number of companies and other financial market and social events. These opinions are current as of the date of this publication but are subject to change. The information provided herein does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.