Newsletter | August 2022

GLOBAL EQUITIES REBOUND AS BOND YIELDS DECLINE

3.4% THE EXPECTED PEAK LEVEL OF THE FED’S POLICY RATE

 

Investment perspective

Following a painful month of June for both equity and bond markets, July looked much like a mirror month as both asset classes performed strongly. In fact, the rebound of markets had started in June already, when expectations relative to the Federal Reserve’s terminal fund rate and bond yields peaked. The decline of yields, combined with an overall reassuring reporting of 2Q earnings, helped equity markets to generate outsized gains, with the MSCI World Index in local currencies climbing by 7.9%. US equities outperformed, especially growth stocks, whereas emerging markets underperformed, largely due to the weakness of Chinese equities. The retreat of bond yields continued at a quick pace; 10-year Treasury yields dropped by 0.36% to end the month at 2.65%, with the equivalent Bund yields falling by 0.52% to 0.81%. Credit spreads also tightened significantly, whereas the US dollar’s appreciation came to a halt, at least temporarily, around the middle of the month.

With more than 75% of the S&P 500’s market cap having reported, earnings have beaten estimates by 4.7%, with 71% of companies topping projections. Earnings per share growth is on pace for 9.8%, assuming the current beat rate for the rest of the season. Even if the beat rate was a little lower than that of the previous quarters, companies’ results can be qualified as solid overall, and guidance has tended to be constructive. Investors reacted positively to the publication of the results of mega-caps such as Apple, Amazon, Alphabet and Microsoft, further boosting the ongoing rally of equity markets. The FED press conference following the July 26-27 FOMC meeting was another supportive factor for equities; Chair Jerome Powell suggested that US rates were near their neutral level so that it was an appropriate time for the Fed to move to a strategy of data dependency.

 

Investment strategy

In our recent mid-year review, we wrote “Our assessment is that a lot of negative news has already been priced in, and market sentiment has become overly depressed”. While we will not pretend to have been anticipating such a strong rally of risky assets in July, it just goes to show how fickle markets have become, and how quickly they can turn around. It also shows that the cutting of exposures when market sentiment is at extreme lows can prove to be very costly. Historical data suggests that equity returns following bear markets, defined as a 20% drop, tend to be well above average over the next two years. That largely explains why we invest over the long term and do not attempt to time the market. We continue to believe that a well-diversified portfolio is the best way to navigate current market conditions, hence our positioning.

Like many we have been astounded by the speed at which some market trends have shifted this year. This reflects an extreme level of uncertainty which has resulted in prices overshooting and undershooting massively. It is still too early to believe we have reached a point of equilibrium following these violent swings so further volatility is to be expected in the months ahead.

MARKETS HAVE REGAINED SOME COMPOSURE WITH CORPORATE EARNINGS PROVIDING REASSURANCE

 

Portfolio Activity/ News

July was a very positive month for the portfolios, with the vast majority of strategies producing monthly gains. The best contributions were provided by the global technology and multi-thematic funds, European Small Caps, US Value and US Growth, the Medtech & Services fund, as well as European and Japanese equities. The fixed-income asset class also contributed positively, thanks to declining risk-free bond yields and tighter credit spreads. Chinese equities, the trend-following strategy and L/S equities were the portfolios’ main detractors; the negative return recorded by the trend-following CTA strategy in July was to be expected considering the inversion of some well-entrenched trends. For non-USD denominated portfolios, the US dollar exposure was also a contributor.

In July we cut one of our more growth-orientated strategies in favour of more defensive ones. We effectively increased the allocation to the real assets and to the stable equity strategies. The objective of these moves is to reduce some of the portfolio’s volatility and to increase the exposure to less cyclical businesses and to assets offering a higher level of protection against inflation.

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Investment Perspectives 2022 | Mid Year review & Outlook

Executive Summary

The economy is facing a sharp slowdown, and visibility is poor

The world economy is slowing down, and early-year GDP growth forecasts have been downgraded materially. The war in Ukraine, lockdowns in China, supply-chain disruptions, and restrictive monetary policies have hurt economic activity severely and hopes for the extension of a strong post-COVID recovery period have been crushed. Russia’s invasion of Ukraine has exacerbated ongoing strains from the pandemic, such as supply chain bottlenecks and significant increases in the price of many commodities. Inflation pressures have also proved to be much more persistent than those forecasted by central banks. The World Bank now expects global growth to reach only 2.9% for the whole of 2022, from a 4.1% projection six months ago. The economy has had to face even more headwinds than expected so far this year and recession risks have kept on rising.

Financial conditions will continue to tighten

The recent period has seen a most dramatic hawkish shift from central banks. Markets are now anticipating the most aggressive and synchronised tightening cycle since the Volcker era of the early 1980s. It has taken some time for central banks to realize how wrong their inflation forecasts had been, and they are now in catch-up mode. The yields of G-7 sovereign bonds have increased at an unprecedented pace. A rise of yields had been anticipated but the speed at which central banks, especially the Fed, have shifted their monetary policies has shocked the markets. In January, markets were expecting three 0.25% rate hikes only by the Fed in 2022 to a level of 0.75%. A month later, five hikes had been discounted, to a level of 1.25%, and by March this expected level had moved up to 2.5%! Current expectations are for the Fed funds rate to end 2022 close to 3.5% and for the terminal rate to reach 4% in 2023. Rate hike expectations from the ECB have also increased significantly, from none expected in January to five at the time of writing to an end-2022 level of around 1%.

The second half will likely remain volatile for financial markets

The first half of 2022 has been brutal for global equity and bond markets. Despite solid 1Q corporate earnings and, so far at least, an overall positive outlook on future profits, equities have dropped significantly because of the rising hawkishness of the major central banks. The combination of higher earnings and lower equity prices means that the derating of valuations, a trend observed since the end of 2020, has continued throughout 2022. Sovereign debt yields have risen at an accelerated pace and credit spreads have widened significantly. Key broad bond indices are down by around 15%, a staggering drop for the asset class. Investors have had to continuously adjust their expectations relative to the policies of the major central banks, which has triggered outsized volatility. In view of the elevated level of uncertainty, due to economic and geopolitical headwinds, we expect financial markets to remain volatile in the near term.

The positioning of the portfolios has become more defensive

Our portfolio positioning has become more defensive, with a neutral allocation towards equities, an overweight in alternative strategies and a fixed-income allocation which is underweight and has a low level of duration. For non-USD denominated portfolios, the US dollar position was also increased, a defensive move. Our equity exposure remains well diversified and some growth equity strategies have been replaced by more defensive ones, a switch that has worked well so far. Our assessment is that a lot of negative news has already been priced in, and market sentiment has become overly depressed. In the current market conditions, the more defensive strategies, including the less cyclically exposed companies, real assets, healthcare, value equities, and quality growth businesses, are likely to continue outperforming. We also like the decorrelation offered by equities of frontier markets, especially as their valuations remain very compelling. In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

 

Table of contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS 
  • MARKETS' OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2022

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Newsletter | June 2022

GLOBAL EQUITIES REBOUND AMID EXTEMELY DEPRESSED MARKET SENTIMENT

$600 bn THE EXPECTED LEVEL OF EQUITY BUYBACKS IN THE FIRST HALF OF 2022

 

Investment perspective

May was an archetypal month of two halves for most asset classes. Global equities extended their early-year decline initially before staging a spectacular rebound. This helped the main indices to record flat monthly performances, even if growth and small cap indices were not able to make up all of their early-month losses. The yields of US Treasuries continued to rise fast until May 6 when they began to climb down from a peak level of 3.2% to end the month at 2.84%. It took longer for credit spreads to start contracting but, then again, the movement was swift, for US high yield bonds in particular. The US dollar ended May on a much weaker note after reaching a multi-year high. The trend that continued to be persistent was the appreciation of the prices of most commodities. With the EU’s agreement of new sanctions against Russia in the form of a partial oil embargo, oil prices climbed by close to 10% in May; low expectations for any further increase of OPEC production and the anticipation of a recovery in demand in China also contributed to this rise.

The high level of uncertainty on many issues continues to weigh on markets and on market sentiment. This has led certain well-followed indicators such as the Fear & Greed Index and the AAII Bull/Bear Index to drop to extremely negative readings. From a contrarian viewpoint, such depressed levels often precede equity rebounds and this proved to effectively be the case in May. Amidst all the doom and gloom hovering over the markets, the corporate sector appears to be a brighter spot. This has been reflected by the significant insider buying of shares by companies’ directors as well as an increase of equity buybacks from record levels observed the previous years. US business sentiment remains optimistic regarding demand even if supply chain and pricing issues remain the biggest concerns.

 

Investment strategy

Some of the latest market movements could be signalling that markets have already priced in a lot of negative news and maybe become too bearish. When looking at historical average stock drawdowns for US equities, the current trough has gone beyond the average non-recession selloff, according to JPMorgan’s quant team. When compared to the average selloffs during recessions, the current drawdown represents around 75% of prior recession bottoms. Were a recession to be avoided, the current market positioning might well prove to be overly defensive. This is reflected by the near record premium of US defensive sectors versus cyclicals. Rather than adopting such a lopsided defensive position, our allocation to equities continues to be well diversified across investment styles, regions, sectors, and market caps.

The past month saw a pause in the rise of US bond yields as well as a decline from peak expectations relative to the end-2022 implied Fed Fund rate. Were these expectations to be anchored around the current levels, this could provide some support for markets.

MARKETS REMAIN VOLATILE AS RECESSION RISKS AND HIGH INFLATION DOMINATE INVESTORS’ MINDS

 

Portfolio Activity/ News

May was a negative month for the portfolios. Even if many global equity indices recorded flat monthly performances, several of our growth-orientated strategies finished in negative territory. Japanese equities, the multi-thematic fund, US small caps and equities of frontier markets were amongst the portfolios’ main detractors. Positive contributions were provided by the European and US Value funds, Chinese equities, the L/S equity strategy, as well as the global technology fund. Most of the bond positions ended with limited losses as US rates started to stabilize and credit spreads contracted towards the end of May. For non-USD denominated portfolios, the US dollar exposure was a detractor in view of the decline of the US currency from its May multi-year high.

We recently attended an event where many fund managers presented their strategies. Whereas equity managers tended to remain unsure about the next move in equity markets, bond managers proved to be more optimistic. Following extensive spread widening, the consensus was that the market now offers decent opportunities in view of much higher carry and solid fundamentals. They also highlighted the fact that refinancing needs remain very low as most companies have taken advantage of record low yields the past years to boost their balance sheets.

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Newsletter | May 2022

GLOBAL BONDS RECORDED THEIR WORST EVER MONTHLY DROP

- 13.3% THE TORRID MONTH OF APRIL FOR THE NASDAQ COMPOSITE

 

Investment perspective

The month of April was a brutal one for financial markets. In an environment where bond yields continued to rise at a fast pace, and the appreciation of the US dollar accelerated, equity and bond markets both ended the month much lower. The MSCI World Index in local currencies plunged by 7%, mainly due to the weak performance of US equities. The Bloomberg Global-Aggregate Total Return Index, a broad bond index, lost 5.5% and recorded its biggest monthly drop since its inception in 1990. 10-year Treasury yields rose by 60bps to end April at 2.94%, and Bund yields with a similar maturity moved up to 0.94%, an increase of 39bps; credit and emerging market debt were also impacted by a widening of spreads. The overall strength of the US dollar was reflected by a 4.7% depreciation of the EUR/USD parity to 1.055, a level last observed more than five years ago.

The main drivers of markets in April were the increasing hawkishness of the Federal Reserve, as well the reporting of first quarter earnings. Markets are now pricing in a 50bps rate hike in May, with same-size hikes also likely to be announced at the following meetings. With more than 80% of the S&P 500’s market cap having reported, earnings are beating estimates by 6.5%, with 77% of companies topping projections. These solid results have not prevented US equities from getting battered during the past month. Some of the darlings of the past years, which contributed largely to the strong outperformance of US equities relative to other regions, have been experiencing a significant derating. Investors have punished high-growth companies such as Netflix which saw subscribers fall for the first time in a decade. Soft guidance from Amazon, a supply constraints issue for Apple and disappointing earnings from Alphabet are just some of the reasons for the poor performance of these companies’ stocks in April.

 

Investment strategy

We are maintaining the current allocation of our portfolios amidst very depressed market sentiment. The Fear & Greed Index is in fear territory, whereas the AAII bull/bear Index is showing the highest level of pessimism since March 2009. Investors are facing massive uncertainty on a number of issues, and markets have become over reactive and prone to huge swings. At the time of writing the Federal Reserve has just hiked by 50bps, as fully expected, but US equities rallied by 3% after Jerome Powell ruled out the possibility of a 75bps hike at a forthcoming meeting. This move appears overdone but reflects the current level of noise across the markets and we prefer to look further ahead and not attempt to trade the market daily.The month of April was another very tough month for fixed-income assets, but we might be approaching a point where the timing looks more favourable for the asset class. A lot of adjustment in risk-free rates has already taken place in view of the expected tightening of central banks, and the outlook for credit remains supportive.

WITH MARKET SENTIMENT BEING DEPRESSED, MARKETS COULD STAGE A NEAR-TERM REBOUND

 

Portfolio Activity/ News

April was a negative month for the portfolios. With both the equity and fixed-income asset classes recording monthly losses, it proved to be a very difficult market environment. The main detractors were the multi-thematic growth fund, US Small Caps, the technology fund, Japanese and Chinese equities, and European Small Caps. The recently added global equity fund exposed to companies with stable returns was resilient as were some emerging market exposures. In the fixed-income asset class, the losses of our exposures were generally less than those of their reference benchmarks, even if the fund with longer duration was obviously badly hit by fast-rising rates.

On a more optimistic note, alternative strategies have continued to outperform and to fulfill their diversification role within the portfolios. Several hedge funds provided positive contributions, in particular the trend-following CTA strategy, thanks to its significant short exposure to rates. For non-USD denominated portfolios, the appreciation of the US dollar also contributed positively to the performance.

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Newsletter | April 2022

MARKETS STAGED A STRONG REBOUND FOLLOWING INITIAL HIT AS WAR BREAKS OUT IN UKRAINE

+ 51bps THE STEEP RISE OF 10-YEAR TREASURY YIELDS IN MARCH

Investment perspective

The month of March was characterised by two distinct periods for financial markets as early-month weakness was followed by a strong rebound of risk assets. The MSCI World in local currencies gained 2.9%, with the S&P 500 ending 3.6% higher, whereas the Euro Stoxx 50 dropped by only 0.6% after recovering most of its early-month losses. This performance of equities was quite impressive considering the dramatic events in Ukraine, and also in view of the significant rise of bond yields. An increasingly hawkish Fed triggered a 51bps rise of 10-year Treasury yields, with 10-year Bund yields also jumping by 41bps. In FX markets, the US dollar appreciated while the Japanese yen plunged by 5.5% vs. the USD, mainly as a result of the diverging monetary policies between the Bank of Japan and the Federal Reserve. It was another strong month for commodity prices, even if those of energy and gold ended the month well below early-March peak levels. Gold spiked to $2’050 per ounce on March 8, before declining significantly to finish the month at a level of $1’937 per ounce.

Since the beginning of the year, bond markets have had a rough ride and the drawdown of bond indices has been severe. This has been firstly due to the impact of the Federal Reserve’s very hawkish shift towards both higher rates and a faster pace of these hikes, and also the upcoming contraction of the central bank’s balance sheet. Markets are now pricing in a 50bps rate hike at the May’s FOMC meeting, with other 50bps hikes also appearing as likely. Corporate credit markets have also been hurt by significant spread widening, whereas positions in Russian and Ukrainian debt has severely hurt investors exposed to issuers from these countries. The first-quarter performances of the main bond indices range from -5% to -10%, meaning that they have more or less been in line with the performances of equity indices.

 

Investment strategy

We are pleased to report that our end-February decision not to cut equity positions at the onset of the war in Ukraine has been vindicated in view of their strong recovery since early March. Our assumption was that the war, as dramatic as any conflict always is, would have only a limited and temporary effect on markets, as often observed historically. Our equity allocation has recently been reduced and, were equities to record further gains, we intend to continue moving their exposure towards a neutral positioning.

The fixed-income asset class has had a challenging start to the year, due to fast-rising rates and wider credit spreads. As a reminder, our allocation to the asset class is underweight, in particular towards investment-grade, and the duration is low overall. Last year’s gradual shift towards more market-neutral strategies such as event-driven or long/short credit has been very helpful this year. These strategies have been much more resilient and much less volatile than most long-only fixed-income strategies.

MARKETS COULD WELL REMAIN RANGEBOUND IN THE NEAR TERM

 

Portfolio Activity/ News

March was a positive month for the portfolios. There was a significant amount of dispersion between the performances of the different funds. Most fixed-income exposures posted negative returns whereas the majority of equity funds ended the month with gains. The best contributions were provided by the metal mining fund, the trend-following CTA strategy, the real assets fund, and the recently added global equity fund. The main detractors were the Chinese equity fund, one of the high yield strategies, as well as long duration bond funds. For non-USD denominated portfolios, the appreciation of the dollar also contributed to the positive performance.

In March, we trimmed some of the positions having outperformed and thus raised the portfolios’ level of cash. We took advantage of the strong rebound of equity markets from their early-March lows to carry out these transactions. We also boosted the exposure to the US dollar and have hence reduced its underweight compared to the reference index. For the balanced portfolios which are not denominated in dollars, the allocation has increased from 10% to 15%.

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Newsletter | March 2022

MARKETS HIT BY HAWKISH CENTRAL BANKS AND DRAMATIC EVENTS IN UKRAINE

- 26% THE COLLAPSE OF THE ROUBLE VS. THE DOLLAR IN FEBRUARY

Investment perspective

It is with a heavy heart that we write this newsletter and our thoughts go out to all the victims of the war in Ukraine. In face of such a human tragedy, to comment on financial markets feels like a somewhat futile exercise but we remain committed to our task.

At the beginning of February, markets continued to price in a higher number of rate hikes by the Federal Reserve and expectations for a rise of rates from the ECB also rose significantly. Equity markets proved to be quite resilient, nevertheless, helped by the reporting of solid earnings generally; there were also some big disappointments, however, from companies including Meta Platforms (ex-Facebook) and Paypal. The second half of the month was mainly driven by the rising geopolitical tensions on the Ukrainian border, and then by the worst case scenario, when Russian forces started to invade Ukraine on February 24th. While European equities dropped steeply that day, as to be expected, US equities ended much higher as they dramatically recovered from a very weak opening. For the whole month, the S&P 500 dropped by 3.1% and the Euro Stoxx 50 by 6%. Big swings were also observed in the bond markets, as an initial rise of long term yields was then mostly erased. The yields of 10-year Treasuries and Bunds rose from 1.78% and 0.01% to 2.05% and 0.32% respectively, before ending February at 1.83% and 0.13%. In the current context, commodity prices have continued to rise, with energy, industrial and precious metals, and grains appreciating strongly. The US dollar ended the month higher, logically, as investors seeked refuge in the greenback.

Investment strategy

The dramatic events in Ukraine have added to the challenges that financial markets had already been facing. Historically, such events had relatively limited and temporary effects on the markets. This seems to be confirmed by their reaction, so far, since the beginning of the Russian invasion. With the obvious exception of Russian assets, European ones have been the worst impacted, as to be expected, but some markets are in positive territory since February 23rd, with others recording limited losses. Our model portfolio’s exposure to European equities has been underweight for some time, essentially due to an overweight towards emerging markets. This explains why we have not cut our allocation to Europe and believe that the broad diversification of the portfolios is well adapted to the current environment. Frequent and sudden rotations between regions, styles, sectors, and market capitalisations should continue to take place at a very fast pace and it is illusory to attempt to constantly be in sync with these shifts.

DEVELOPMENTS IN UKRAINE TO DRIVE MARKET SENTIMENT IN THE NEAR TERM

Portfolio Activity/ News

February was a negative month for the portfolios. As in the previous month, both bond and equity markets were weaker due to rising yields, wider credit spreads and deteriorating market sentiment. European Small Caps and Value, the global technology fund, and emerging market debt were the main detractors. Some positive contributions were provided by the exposure to gold, the healthcare fund and the metal mining fund, which benefited from rising commodity prices. In the alternative space, the long/short credit funds, the Event- Driven strategy, the CTA and Global Macro strategies were resilient and played their part as portfolio diversifiers.

In February, we made some switches in the model portfolios. The emerging markets’ growth equity strategy was replaced by an Asia ex-Japan fund with a value approach. The purpose is to benefit from extremely low valuations for the fund’s companies and to reduce some of the overlap with the China equity fund. A global fund with a focus on growth was also replaced by another global equity fund exposed to “boring” businesses with stable returns. The objective, in both cases, was to reduce some portfolio volatility and to rebalance the allocations to growth and value funds.

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Newsletter | February 2022

A HAWKISH FED SENDS GROWTH STOCKS TUMBLING

- 9% THE JANUARY DROP OF THE NASDAQ COMPOSITE INDEX

Investment perspective

Financial markets have got off to a very volatile start in 2022 largely due to the increasingly hawkish tone of the Federal Reserve, but also in view of a lack of visibility on several key issues. The US equity markets underperformed as growth stocks were badly hit by the prospect of rising interest rates. European and UK equities proved more resilient as they benefited from a rotation into value stocks, more highly represented in their indices. Significant rises of bond yields were also observed with short-term US ones the most impacted by the anticipation of a higher number of interest rate rate hikes; 2-year Treasury yields thus rose from 0.73% to 1.16%. Even if Eurozone yields also increased, the widening of the interest rate differential between Treasuries and Bunds underpinned the US dollar. Finally, the commodity complex appreciated strongly, with the biggest moves recorded by energy and industrial metals.

The most likely path of the Federal Reserve’s monetary policy has been reassessed continuously by investors since the beginning of the year. The hawkish pivot of the central bank in December moved to a new level, making markets very choppy on concerns that the Fed mighty tighten policy even more than expected. The mention in January of an upcomig reduction of the Fed’s balance sheet took investors by surprise, and a first rate hike in March now appears as a done deal. The following steps are less predictable even though markets are now pricing in five hikes in 2022 compared to three at the beginning of the year. Notwithstanding the prospect of higher interest rates, investors remain confused by the level of uncertainty that the central bank, and Powell in particular, is predicting. Added to the uncertainy over inflation, supply chains, the pandemic and the situation on the Ukrainian border, it is not surprising that markets were badly shaken during the past month.

Investment strategy

Following a solid end to 2021 for financial markets, January has provided a stark reminder of how quickly conditions can change. The speed at which the Federal Reserve is looking to normalize its monetary policy is destabilizing the markets and it will likely take some time for an equilibrium to be found. Our base case scenario still favours equities as being the main drivers of portfolio performance, and we are prepared to tolerate higher volatility in the near term in view of our longer-term outlook. Economic growth should remain above its long-term potential and corporate earnings are expected to grow further, even if at a slower pace. From a historical perspective, the beginning of a tightening cycle by the Fed has not prevented positive equity returns as long as the rise of rates is gradual, and a recession is not in sight.

Markets are likely to be much more challenged in the year ahead. Less supportive monetary policies, a decelerating trend of earnings growth, elevated economic and pandemic-related uncertainties are the main headwinds they will have to face. These factors largely explain why we anticipate more moderate portfolio returns in 2022.

MARKETS TO REMAIN VOLATILE AS ELEVATED UNCERTAINTY UNLIKELY TO DISSIPATE SOON

Portfolio Activity/ News

January was a disappointing month for the portfolios. With both bond and equity markets dropping simultaneously, the majority of funds detracted from the performance, as to be expected. US Small Caps, the Multi-thematic fund, European Small Caps, the global technology fund and one of the Japanese funds were the main detractors. On the positive side, some positive contributions were provided by the European Value fund, long/short equities and the UK Value fund. For non-USD denominated portfolios, the appreciation of the dollar was also a positive contributor. In the alternative space, the long/short credit funds and the Event-Driven strategy had limited drawdowns, whereas the CTA and Global Macro strategies fared less well. The selection of active managers is at the core of our invest-ment approach, with the objective of generating significant alpha relative to benchmarks over the long term. There will be periods when we must accept some underperformance relative to a more passive approach. We are currently going through such a period and will be looking for our active funds to catch up their gap and re-establish their long-lasting track-record.

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Investment Perspectives 2022

Executive Summary

2021 was another positive year for risk assets

2021 was less stressful for investors than 2020, but it was an eventful year, nevertheless. Markets proved to be resilient, overall, and trends were quite entrenched. The different asset classes behaved mostly as we had expected, with equity markets moving higher, credit spreads tightening, and bond yields rising. The appreciation of the US dollar was more of a surprise, as was the severe underperformance of emerging markets, in large part due to heavy-handed regulatory interventions in China and political issues in Latin America.

The growth of corporate earnings was even stronger than forecasted. This growth drove equity prices much higher in developed markets, accompanied by a compression of valuations. As in 2020, rotations between investment styles and sectors were much in evidence, with the initial outperformance of value stocks being gradually clawed back. The above-average gains of the US mega-caps was also striking, making it difficult for active managers to beat the returns of indexes.

Central banks are facing serious challenges

Central bankers will be put to the test in the year ahead. They will need to find the right balance between their fight against inflation pressures, which they have underestimated, and the risk of withdrawing liquidity too quickly. Their task will not be made easier in view of the unpredictable evolution of the pandemic. The Federal Reserve has been more forthright than the European Central Bank in regard of its plan to unwind its asset purchase program and to raise interest rates thereafter. Following the projected end of its tapering in March, the Fed will then have to decide when to start hiking the fed fund rate. Current expectations are for this rate to be raised three times by 0.25% in 2022 from the current target rate of 0%-0.25%. The Fed’s communication has contributed to contain market volatility, at least so far, but a policy mistake could easily derail the prevailing positive market sentiment and trigger a correction of asset prices.

Markets are likely to look beyond the threat of new COVID-19 variants

The global economy is projected to grow 4.9 percent in 2022, according to the IMF, a growth rate which remains above average as the recovery continues. Recurring coronavirus outbreaks have created stop-and-start economies and governments worldwide will be hoping for a smoother recovery in the year ahead. This would contribute to resolve some of the ongoing supply chain bottlenecks. Each time new COVID-19 variants were found, capital markets recovered very quickly from brief periods of higher volatility. This behaviour of markets should persist, especially if new strains were to prove increasingly less virulent, as is the case with Omicron.

We still favour equities despite their smaller appreciation potential

We expect equities to be the main contributors to the performance of portfolios in the year ahead. Global earnings are forecasted to grow by 10% to 15% and they will be the main driver for the equity asset class as valuations are not expected to expand from the current levels. We anticipate more modest returns for the portfolios in 2022. Equities are unlikely to match their performances of 2021, whereas the environment will remain challenging for fixed income assets as key central banks tighten their policies to fight against elevated inflation pressures.

 

Table of contents

  • EXECUTIVE SUMMARY
  • 2021: REVIEW OF OUR INVESTMENT THEMES
  • 2021: ECONOMIC & POLITICAL DEVELOPMENTS
  • 2021: THE FINANCIAL MARKETS 
  • 2022: ECONOMIC OUTLOOK
  • 2022: FINANCIAL MARKETS' OUTLOOK
  • 2022: ASSET ALLOCATION

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Newsletter | December 2021

A NEW COVID VARIANT AND A MORE HAWKISH FED SPOOK THE MARKETS

- 20.8% A PLUNGE OF WTI OIL PRICES IN NOVEMBER

Investment perspective

Following a positive start to the month, global equities ended November on a very weak note as investors were spooked by the discovery of a new Covid variant, Omicron, in southern Africa. This late-month news was compounded by Jerome Powell’s more hawkish tone, indicating his willigness to speed up the Fed’s tapering. The MSCI World Index in local currencies fell by 1.6%, with European equities underperforming and US equities proving to be much more resilient. In a risk-off market environment towards the end of the month, government bond yields tumbled. 10-year Treasury yields declined from a month-high of 1.66% to 1.44% and 10-year Bunds ended the month 0.24% lower at - 0.35%. A most dramatic move of oil prices was also observed in November. Concerns over weaker demand due to lockdowns in Europe and the new Covid variant pushed the price of a barrel of WTI oil 21% lower.

At a time when markets were already under stress due to concerns about the effectiveness of vaccines to tackle the new Omicron strain, the Federal Reserve’s Chair, Jerome Powell, signalled his support for a faster withdrawal of the central bank’s asset purchase programme. During his first testimony to Congress following his nomination for a second term, Powell proved to be significantly more hawkish on inflation than previously. His comments led to a further drop of equity markets, especially as investors had wagered that the Federal Reserve would take a more patient approach to raising rates due to the emergence of the new Omicron variant. The shifts of expectations relative to rate hikes were reflected by the whipsaw of 2-year Treasury yields during the month. After initially declining from 0.49% to 0.4%, they then spiked up to 0.64% before ending November at 0.5%.

Investment strategy

In view of the high uncertainty surrounding the latest Covid variant, we have decided to stay the course and not take any rash decisions. Based on previous episodes when new Covid variants were discovered, market drawdowns proved to be limited and fleeting. We are unable to predict the effective-ness of the current vaccines against the Omicron strain, we thus prefer to focus on the underlying fundamentals at both a macro and corporate level and continue to invest for the longer term. We do, however, fully expect markets to remain more volatile than they have been throughout most of 2021. The portfolios are well diversified and not reliant on one par-ticular investment style, especially as significant market rotations are likely to remain a factor in the near term.

Volatility has remained high in the bond markets as investors try to take account of a more hawkish Federal Reserve at a time when Covid-related uncertainty has risen. Our base case scenario is still for yields to gradually increase in the months ahead and our overall duration risk is low. Our focus is on high-yield credit, senior secured loans, convertible bonds, as well as emerging market corporate debt.

MARKETS TO REMAIN CHOPPY AS UNCERTAINTY RISES AND FED TURNS MORE HAWKISH

Portfolio Activity/ News

After getting off to a strong start, November turned out to be a negative month for portfolios. US Small Caps, European Value, the CTA trend-following strategy, the Multi-thematic fund, EM growth and healthcare equities were the main detractors. On the positive side, the best contributions were provided by the global technology fund, US growth, metal mining equities, and the Japanese growth exposure. For non-USD denominated portfolios, the appreciation of the dollar was also a positive contributor. Most fixed-income positions ended the month with modest variations, except for the EM corporate debt fund which extended its decline observed since the end of August, in large part due the crisis in the Chinese real estate sector. The fund remains a top performer within its peer group over different periods, nevertheless, and the manager is confident of the opportunities ahead. We consider this position to be the one providing the most potential within the fixed-income asset class.

Apart from the CTA strategy, other hedge funds were stable and showed their usefulness within the portfolios. The poor performance of the trend-following strategy was the result of the sudden reversal of bond yields, weaker equities and a widening of credit spreads. This kind of return pattern is well understood and is to be fully expected when well-entrenched trends reverse brutally. Were these trends to invert more permanently, this systematic strategy would then adjust its exposures accordingly. End

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Newsletter | November 2021

A SOLID Q3 EARNINGS SEASON UNDERPINS THE EQUITY MARKETS

+ 5.4% A STRONG MONTH FOR THE MSCI WORLD IN OCTOBER

Investment perspective

Global equity markets performed strongly in October under the leadership of US equities. The MSCI World Index in local currencies rose by 5.4%, with the S&P 500 climbing by 6.9%, but emerging markets and Japanese equities did not take part in the rally. The Brazilian equity market was particularly weak, on concerns over excessive public spending plans, whereas Japanese equities were also under pressure ahead of October 31 general elections. It was a quite volatile month for bond markets, with early-month rises of sovereign debt yields followed by a partial unwinding, at least on the longer end of the curves; this was due in part to big swings in inflation expectations. The yields of 10-year US Treasuries rose by 6bps in October but 2-year ones ended the month 20bps higher, resulting in a much flatter curve. There was also a lot of action within the commodity markets, as energy prices extended their rally and divergent trends were observed on industrial metals.

With 82% of the S&P 500’s market cap having reported, 79% of the companies have beaten earnings’ estimates and 72% revenue estimates. Overall, third-quarter earnings are beating expectations by 10.5% and revenues by 2.9%. The results of European companies have also surprised positively, even if to a lesser degree. However, both regions are producing similar earnings per share (EPS) growth of above 35% year on year. These solid corporate results have contributed to reassure investors which had lowered their expectations ahead of this reporting season. As a result, equity markets have rebounded strongly and appear to be on a firmer footing again. The fact that profits have proved to be resilient despite rising costs, and that fewer companies than feared have warned on future profits, has definitely boosted the equity asset class.

Investment strategy

As many investors, we have been comforted by the ongoing reporting of Q3 corporate results. The portfolios’ overweight equity allocation is benefiting from the current strength of equity markets. Even if bond markets appear to increasingly disagree with the timeline of interest rate hikes by the ECB and the Federal Reserve, this has not triggered any negative reaction by equity markets so far. The Fed’s announcement following its FOMC November 2-3 meeting that it would start reducing its purchases this month was well flagged and taken in its stride by markets. Concerns over persistent high levels of inflation have not disappeared but, as long as they do not become the main drivers of markets, equities should remain the asset class of choice.

It has been interesting to observe that the price of gold has appreciated in October despite the pressure on bond yields. This likely reflects the fact that gold is considered as a good hedge against inflation in view of rising expectations. We also anticipate other positions in the portfolios such as the mining equities and the fund investing into real assets to represent good hedges against higher inflation.

RECENT VOLATILITY WITHIN BOND MARKETS HAS NOT IMPACTED EQUITIES SO FAR

Portfolio Activity/ News

October was a very positive month for the portfolios, mainly thanks to the strong performance of many equity funds. The multi-thematic fund, European small caps, frontier markets, and mining equities provided the best contributions; the European value fund also continued to perform well and we much like the way the fund is positioned. As in September, most fixed-income funds ended the month little changed. Our emerging market corporate bond fund had a negative month, however, in part due to a difficult market for Chinese corporate bonds. Other negative contributions were far and few between, but included our UK equity fund and another one investing into Japanese equities. In the alternative space, the CTA fund performed well, whereas the other strategies were mostly stable.

One of the challenges ahead of us will be the replacement of some of the portfolios’ long-only equity exposures by less directional strategies, especially as the fixed-income asset class is still very unattractive. Our search for new funds is therefore currently more focused on liquid hedge funds, with long/short credit and convertible arbitrage being some of our main interests at the moment.

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