Here’s why your clients probably didn’t beat the S&P 500 in 2016

Your clients had a great year in the stock market. But their first question might be, “Why didn’t we get as much as the S&P 500?”
The Standard & Poor’s 500 stock index gained 11.96% with dividends reinvested in 2016, despite a rough start: The blue-chip index fell 10.50% from the beginning of the year through February 11. But even with an all-stock portfolio, there were plenty of ways to underperform:
• The growth lag. The average large-company blend fund, the closest to the S&P 500 in composition, gained 10.27%. The difference in performance can largely be chalked up to expenses. The average large-company growth fund, however, gained just 3.14% — a number that’s popular in some circles, but probably not your clients’.
• The overseas swoon. Adding international funds in 2015 meant that your clients lost money with a certain savoir faire. Doing the same in 2016 meant your clients lagged the S&P 500 with a bit more joie de vivre. But they still lagged, and badly: The average large-cap foreign blend fund gained just 0.67%, or slightly more than the average money market fund.
• The bond bog. The yield on the bellwether 10-year Treasury note rose to 2.45% the end of 2016 from 2.27% at the end of 2015. (It had swooned to an all-time low of 1.34% in July). If investors were lucky, they got their interest payments, less expenses. For the typical intermediate-term bond fund, that translated into a 0.87% return.
• The alt angst. No category in Morningstar’s alternative subcategory gained more than an average 3.01%. (That would be multicurrency funds.) Managed futures funds lost an average 3.07%. Broad commodities, which are not part of the alternative subcategory, did rise 11.69%, aided by a rise in gold, the dollar and oil.
All three of these types of funds are common diversification fodder for advisers. Assuming you told investors you were trying to diversify and reduce volatility, you probably won’t get much blowback. If any of these were supposed to be your secret sauce for outperformance, you probably won’t get many compliments on your cooking.
But other categories fared spectacularly well. Small-cap value funds, for example, ended the year with a 25.80% gain. In fact, all value-oriented funds beat their growth and blend peers as energy and oil, perennial value playgrounds, rebounded.
And all wasn’t wailing and gnashing of teeth overseas. Latin America funds soared 29.77%, and diversified emerging-markets funds gained 8.01%. Europe, wracked by Brexit fears, fell an average 2.09%, and China funds, clobbered by a sell-off at the start of the year, tumbled 2.32%.
Clients who took risks in the bond market were rewarded. High-yield bond funds outperformed the S&P 500, gaining 13.3% for the year, and emerging-markets bond funds added 9.99%, according to Morningstar.
Gold bugs shone in 2016. Funds that invest in the yellow metal itself hammered out an average 10.11% gain. But funds that invested in the stocks of gold mining companies soared 52.7%.
And among sectors, the worst of 2015 became the best. Energy funds gushed an average 29.23%, and energy MLP funds, snakebit in 2015, got up and danced last year with a 26.92% gain. Worst performers: Health-care funds, down 10.96%.
Is it better to invest in last year’s laggard sectors, or its gainers? Sam Stovall, chief investment strategist for CFRA, suggests both. Buying the 10 worst sub-industries and the 10 best sub-industries has produced an annual average gain of 13.60% since 1991. Last year, the “barbell approach” gained 15.1%.