Investments Overview
1693 Partners Fund
Coming into the fiscal year, markets were pricing in a deep recession and adjusted down valuations accordingly. When that recession didn’t come (or at least hasn’t come yet), investors recalibrated those expectations and in doing so equities rallied. While the Federal Reserve continued its campaign against inflation by raising its policy rate to 5.25% by the end of the year, the U.S. economy has been resilient in the face of this rapid increase and has adapted to a higher interest rate environment. The sustainability of this healthy economy will be the critical question that investors will deal with as the Federal Reserve has consistently communicated that it will leave policy rates sufficiently higher for longer to make sure inflation is firmly under control.
The MSCI AC World Index, an index that measures global equity returns, returned a positive 17.1% for the fiscal year and is roughly flat for the two-year period, including both fiscal years 2022 and 2023. Fixed income investments continued to struggle to produce positive returns. The strong returns in the equity markets masked the underlying narrowness of the market in terms of the number of companies participating in that strong performance. For example, the S&P 500, a broad measure of the U.S. market, returned 19.6% for the year. However, the top 5 contributors accounted for 42% of that total return. The equally weighted S&P 500 produced a 13.7% return.
Within this macro environment, the 1693 Partners Fund produced a 7.1% return for the fiscal year. Given the wide range of economic scenarios that were possible at the start of the year, we are reasonably happy with the results. These short-term results did, however, trail the Policy Benchmark, which gained 12.1% over the same one-year period.
As I will continue to point out, it is not what happens in any one-year period that defines a successful investment strategy; the best gauge is reviewing longer-term results. I am pleased to report that longer-term performance numbers continue to be strong and comfortably ahead of the benchmark. The table below details the longer-term results for the portfolio. The Partners Fund also hit an important milestone in terms of assets under management. As of June 30, 2023, the Partners Fund now has net assets of $1.029 billion, the first time the pooled endowment has breached the billion-dollar level.
Investment Performance
In light of the more encouraging macroeconomic environment, the portfolio’s investments in Global Public Equities returned a positive 19.9% for the fiscal year, compared to the MSCI All-Country World, its benchmark, which produced a positive 17.1%. As of June 30, 2023, Global Public Equities represented 47.3% of the aggregate portfolio. In terms of geography, the best performing sub-asset class was Developed International Equities.
The portfolio’s U.S.-focused public equity investments, with a weighting of 24.7%, returned a positive 21.3%, compared to a return of 19.0% return for the Russell 3000 index. Small cap exposure and idiosyncratic manager performance led to favorable results in the fiscal year.
Developed International Equities, accounting for 19.0% of the portfolio, returned 23.4%, outperforming the MSCI EAFE benchmark by 463 basis points. The Emerging Markets allocation continued to be the most challenged from an absolute and relative return point of view and underperformed its benchmark during the fiscal year. The portfolio continues to have a modest weighting of 3.7% invested in emerging market equities, as concerns around China’s uneven economic recovery from COVID lockdowns persist.
Private Equity, which includes venture capital, buyout and growth equity investments in private companies, had the second largest allocation in the portfolio at 20.0%. Private equity valuations are generally less volatile given that private assets are not re-valued in line with the daily ups and downs of the public equity markets. This mismatched effect played out in FY23, as the portfolio did not experience the rapid increase in valuations witnessed in the public markets. In addition, the less certain macroeconomic environment has dampened growth prospects for smaller, earlier-stage private companies, especially investments in venture capital. Notably, this public-private return mismatch had the opposite effect in FY22. When considering the two-year return, it is apparent that the mismatch is somewhat neutralized with a return of 6.0% for the private equity portfolio versus the benchmark return of negative 8.3%.
Longer-term results, which is how return comparisons are best interpreted, remain quite strong on an absolute basis and excess returns of private markets relative to public markets are compelling. We continue to manage this allocation carefully and are committing additional capital thoughtfully. We are mindful that oftentimes the best vintage years of private equity performance are after periods of heightened volatility, where capital is constrained, and valuations are normalized. Therefore, remaining engaged and active is key to a successful private equity program.
As mentioned in last year’s report, having exposure to strategies that can potentially diversify investment risks away from traditional public equity and fixed income risk generated solid investment returns this year. The Partner Fund’s exposure to these types of investments, which are categorized as Diversifying Strategies, summed to 12.2%, an increase of 2.0% from the end of last fiscal year. This allocation includes investments in private credit, specialty finance, hedge funds, and non-correlated strategies including cash flow-based royalty investments and produced in aggregate a positive 4.5% return for the fiscal year.
Fixed Income assets within the portfolio remain modest at 3.1% of the portfolio. Interest rate sensitive markets were still grappling with the continued rise in monetary policy rates to combat higher than anticipated inflation. This provided a continued headwind to traditional fixed income investments as yields and prices are inversely related. However, credit spreads remained stable in the face of rising short-term risk-free rates. While it does appear that central bankers are at the end of their tightening cycle, the markets were priced to have those rates hikes reversed and for a rate cutting cycle to occur by the end of the year. Those judgments now appear to be optimistic as the Federal Reserve has committed to keeping rates elevated for longer.
We remain cautious with the exposure to traditional fixed income and in this environment, we prefer to hold cash like instruments yielding 5.5% rather than assume duration or interest rate risk.
Finally, Real Assets, with an 11.7% weighting in the portfolio, had meaningful exposure to real estate. In FY23, the Real Assets portfolio essentially was flat. The portfolio’s exposure to the commercial office market led to weak returns but that was offset somewhat by modest returns in the remaining sectors of the real estate market. The portfolio’s exposure to the energy infrastructure market generated positive returns, while its position in the commodities space produced negative returns. We are still optimistic about both sectors and remain comfortable with the allocation on balance.
Brian Hiestand
Chief Executive Officer & Chief Investment Officer
1693 Management Company, LLC
