By Brian Levitt, Senior Economist
Since the financial crisis, investors have generally preferred income-generating assets, favoring the perceived safety of government bonds and higher yielding equity sectors like utilities, telecom and staples. A portfolio comprised of government bonds and defensive, higher yielding equities performed well until the summer of 2013. Then, at the mere mention by Federal Reserve officials of a future tapering of asset purchases, those assets, which are particularly interest rate sensitive, were sent tumbling, creating losses for investors in assets that they had viewed to be less risky. The so-called “taper tantrum” proved to be for naught as the Fed maintained its level of asset purchases and the higher interest rate sensitive assets recovered some of their losses.
Recent U.S. economic releases have been mixed but the latest jobs report, coupled with improving survey data in both the manufacturing and service sectors, has many believing that tapering in late 2013 or early 2014 may be in the offing. We do not believe a reduction in asset purchases is imminent but we would expect a scaling back of asset purchases in 2014 as economic conditions improve. Higher interest rate sensitive assets might not fall to the extent they did in the summer of 2013, but the episode may provide a framework on how different assets may perform.
From the time period when interest rates first began to rise on May 2 through the peak in rates on September 5, high yielding equities that look like bonds (“dividend payers”) and high duration investment-grade fixed income assets performed poorly. On the flipside, assets that historically tend to perform better—albeit with potential greater standard deviation of returns—in improving economic environments, such as industrial stocks, U.S. dividend growth stocks, global equities and senior loans, all outperformed core bonds. History doesn’t always repeat itself but it often rhymes. While past performance may not guarantee future results, we believe that investors will be better served positioned in assets which have historically benefited from improving economic conditions rather than in more defensive, more interest rate sensitive assets.
The original commentary is available at OppenheimerFunds.com.
Standard deviation is a statistical measure that captures how much dispersion a data set has from the average of the data set. It is a common measure of volatility in the financial industry.
The S&P 500 Index is a market capitalization-weighted index designed to measure the performance of large cap stocks in the United States.
MLPs: The Alerian MLP Index is a composite of the 50 most prominent energy master limited partnerships (MLPs).
Core Bonds: The Barclays U.S. Aggregate Bond Index is an investment-grade domestic bond index.
Senior Loans: The Credit Suisse Leveraged Loan Index tracks the performance of senior loans.
Global Equities: The MSCI ACWI (All Country World Index) is designed to measure the performance of developed and emerging equities across the global equity landscape.
S&P GICS Sectors – Utilities, Telecom and Industrials are classified by the Global Industry Classification Standard (GICS) which divides the S&P 500 index into 10 groups based on industries. It is market-capitalization-weighted and the index measures the performance of their respective industries
Dividend Growers: Based on equal-weighted geometric average of total return of dividend-growing historical S&P 500 Index stocks, rebalanced annually. Uses actual annual dividends to identify dividend-growing stocks and changes on a calendar-year basis.
Listed indices are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any fund. Past performance does not guarantee future results.
Special risks: Mutual funds are subject to market risk and volatility. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes and political and economic factors. Investments in emerging and developing markets may be especially volatile. Fixed income investing entails credit risks and interest rate risks. When interest rates rise, bond prices generally fall, and the Fund’s share prices can fall. Below-investment-grade (“junk” or “high yield”) bonds are more at risk of default and are subject to liquidity risk. Senior loans are typically lower rated (more at risk of default) and may be illiquid investments (which may not have a ready market). There is no guarantee that the issuers of stocks held by mutual funds will declare dividends in the future, or that if dividends are declared, they will remain at their current levels or increase over time. Investing in MLPs involves additional risks as compared to the risks of investing in common stock, including risks related to cash flow, dilution and voting rights. Each Fund’s investments are concentrated in the energy infrastructure industry with an emphasis on securities issued by MLPs, which may increase volatility. Energy infrastructure companies are subject to risks specific to the industry such as fluctuations in commodity prices, reduced volumes of natural gas or other energy commodities, environmental hazards, changes in the macroeconomic or the regulatory environment or extreme weather. MLPs may trade less frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in buying or selling. Additional management fees and other expenses are associated with investing in MLP funds. The Oppenheimer SteelPath MLP Funds are subject to certain MLP tax risks. An investment in an Oppenheimer SteelPath MLP Fund does not offer the same tax benefits of a direct investment in an MLP. The Funds are organized as Subchapter “C” Corporations and are subject to U.S. federal income tax on taxable income at the corporate tax rate (currently as high as 35%) as well as state and local income taxes. The potential tax benefit of investing in MLPs depend on them being treated as partnerships for federal income tax purposes. If the MLP is deemed to be a corporation, its income would be subject to federal taxation at the entity level, reducing the amount of cash available for distribution which could result in a reduction of the fund’s value. MLP funds accrue deferred income taxes for future tax liabilities associated with the portion of MLP distributions considered to be a tax-deferred return of capital and for any net operating gains as well as capital appreciation of its investments. This deferred tax liability is reflected in the daily NAV and as a result a MLP fund’s after-tax performance could differ significantly from the underlying assets even if the pre-tax performance is closely tracked. Diversification does not guarantee a profit or protect against loss.
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