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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