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Portfolio Manager Update


Key points at a glance

  • 2022 – If only things were always so clear-cut.
  • 2022 – Will be remembered unfavourably
  • 2022 – Year of key rate hikes and price losses in bond markets
  • 2022 – Hopes that inflation would fall in the second half of the year
  • 2023 – Further key rate rises; the ECB has more to do
  • 2023 – Further caution in the new year, but much better starting conditions

31/12/2022 - Many investors will remember 2022 unfavourably as a year of heavy losses. For our Ethna-DEFENSIV team, however, it was a rather straightforward year, albeit with a slightly negative overall performance. All the trend signs were there as early as the beginning of the year; essentially, higher yields, rising inflation and the substantial interest rate hikes by central banks. And even though the full extent was unclear at the start of the year, the yields in this environment – close to record-lows – sounded the alarm.

The Ethna-DEFENSIV portfolio had been prepared for rising yields back in 2021. We had sold our equity positions in November 2021 and, at the start of 2022, the average duration in the bond portfolio was just under 4. Additional interest rate futures positions further reduced the duration and thus the interest rate risk. Over the course of the year, we further improved the quality of our bond portfolio and duration was down to 2.2 by year-end. Over and over, we adjusted the additional hedging using interest rate futures over the course of the year. We only completely divested ourselves of these hedging positions once, and this was as a result of the Russian invasion of Ukraine. However, we quickly reinstated our additional hedging when it became clear that exploding energy costs were only fuelling inflation more. In addition, the central banks were unwavering in their cycle of interest-rate hikes, as the labour markets in Europe and the U.S. continue to experience surplus demand and wage pressure is high.

In the second half of the year, however, our cautious positioning was twice put to the test. Throughout July, yields on long-dated bonds fell sharply for no apparent reason. As this point, 10-year Bunds were only yielding 0.75% and their U.S. counterparts just 2.5%. Yields subsequently rose amid rapid rises in central bank interest rates coming at a blistering pace of 75 basis points each meeting. In the fourth quarter, too, yields on long-dated bonds initially rose sharply on the back of hopes that inflation in the U.S. may have peaked. However, central banks made it clear that they would continue to raise key rates and then leave them at that level for an extended period, giving as their reason for doing so that they did not expect the current key rate level to be restrictive enough to keep inflation at 2% in the long run. No doubt, the notion that it is comparatively easy to bring inflation back below 5% is a factor in this. However, going from 5% to 2% will take considerably more effort and, above all, persistence.

Will 2023 be the same story as 2022?
Central banks will initially continue to raise key rates. However, overall, the magnitude of hikes will be lower than in 2022. A few substantial increments are still expected to come from the ECB in particular, as it reiterated at its last meeting in December. We believe an interest rate level of around 4% in summer 2023 is quite conceivable and, if so, 2023 will be almost identical to 2022, at least as far as the ECB is concerned. Inflation in the eurozone is still up at 10% at the end of 2022 and the member states of the eurozone are launching massive support programmes for their citizens – with the unfortunate consequence that inflation will linger and the ECB will put up strong resistance. The Federal Reserve will continue to raise its key rate to around 5%, but the scale of interest rate rises will be much smaller than that of last year.

Overall, the Ethna-DEFENSIV team remains cautious; the bond portfolio duration is low for the time being and the focus on high-quality issuers remains in place. While we adhered to our strategy throughout almost the whole of 2022, we expect to be able to take greater risks again in 2023 and also to be able to benefit from temporary falls in yields. Strict and rigorous risk mitigation is no longer necessary given that yields have already risen sharply. The average return of bonds within the Ethna-DEFENSIV has risen to 4.7% despite the higher quality and reduction in duration. The current rate of return is a manageable 2.3%, as we still have lots of bonds with low coupons of 0% to 3% and prices well below 100% in the portfolio. However, by constantly switching to attractive new issues, the current rate of return will rise steadily and approach the average return.

Fund positioning

Figure 1: Portfolio structure* of the Ethna-DEFENSIV

Figure 2: Portfolio composition of the Ethna-DEFENSIV by currency

Figure 3: Portfolio composition of the Ethna-DEFENSIV by country

Figure 4: Portfolio composition of the Ethna-DEFENSIV by issuer sector


Key points at a glance

  • 2023 will also be dominated by volatile risk markets likely to trend sideways
  • We are starting the year with a neutral equity exposure of 18% in a diversified portfolio
  • Countercyclicality is expected to offer the most attractive risk/reward profile
  • The exposure to U.S. dollars is currently 15%; the modified duration is +1.6%

31/12/2022 – It’s hard to believe from the vantage point of the present that just twelve months ago global equity indices were at or close to their all-time highs. 10-year interest rates in Germany were still in negative territory and comparable U.S. papers were yielding almost 1.5%. Although we were already seeing a discrepancy between early economic cycle, exorbitantly high valuations and an already very advanced monetary and fiscal policy, we still expected a phase of above-average growth. This expectation was, however, quickly shattered by various developments. Firstly, the conflict between Ukraine and Russia escalated into conventional warfare with all the attendant fallout, not least for Europe’s energy supplies. Secondly, China’s zero-tolerance policy in relation to COVID-19 not only meant that supply shortages continued for the rest of the world, but there was also a huge slowdown in domestic growth. At the same time, inflation the like of which we have not seen for decades caused Western central banks to change their approach once it went past the 10% mark. A wait-and-see attitude in 2021 transitioned almost seamlessly into a period of rigorous inflation control. This led not only to rapid interest rate rises but also heralded the end of the ineffable negative/low interest rate era. Long underestimated, but in fact a very clearly defined objective of this policy was to substantially reduce demand in order to stabilise prices. In addition to the necessary adjustments in valuations brought on by interest rates – especially in growth stocks, whose prices were in cloud cuckoo land – there was also a shift in asset class correlation. The result was a perfect storm for well-diversified – in theory, at least – multi-asset products; in practice, both equities and bonds experienced losses. In addition, the V-shaped recovery in risk markets we have so often seen in the past ten years did not occur on this occasion. Instead, investors were faced with a persistent bear market that made aggressive attempts to rally time and again, which ultimately failed.

Of course, this environment was very challenging for the Ethna-AKTIV management as well. However, this crisis also gave us the opportunity to put the often-repeated properties of our approach – active management, flexibility and risk management – to the test in positive terms. Even though the fund was still in negative territory at the end of the year, one positive is that the measures taken have helped minimise both volatility and the decline in value. What was particularly helpful was that the credit quality of the bond portfolio had been increased even before the start of the year and the interest rate exposure of the portfolio was hedged in time and even aggressively overhedged at times. Thus, in one of the worst years for bonds in decades, the Ethna-AKTIV even managed to wring a slightly positive contribution to performance from its fixed income segment. In addition, we took advantage of the falls in prices in order to successively expand the bond portfolio at more attractive levels – a decisive step towards making attractive returns in the coming years. Currencies also made a slightly positive contribution. However, it must be said that our strongly positive opinion on and positioning in the U.S. dollar generated a performance that peaked above 3% up to the end of September. However, this was completely wiped out by the extremely sharp fall in the value of the U.S. dollar in the last quarter, which we did not anticipate. The contribution to performance from equities was slightly above the market level. While the high equity allocation from the beginning of the year was quickly adjusted to the crisis environment, no further alpha could be squeezed out with tactical measures, which we did take. We broadened the diversification of the underlying base portfolio (25%) over the course of the year, which proved the right thing to do given the high level of volatility. All in all, avoiding the biggest stumbling blocks of 2022 meant that, compared with the general global markets where returns were profoundly negative, the fund only made a moderate loss, thus laying the foundation for generating an attractive return in the longer run.

Looking ahead, the economic environment still looks very fragile. The restrictive policy of Western central banks is slowly but surely having the desired cooling effect. As for the question of whether recession is coming in the near future, analysts seem to be more on the same page than ever. This realisation alone sounds a note of caution in a positive sense. After fixating on when inflation would peak, the markets have now moved on to the recession narrative. Interestingly, by inverting the yield curve, the U.S. bond market has priced in this risk quite a bit higher than the equity market. In terms of the markets in 2023, in addition to the economic data, the focus is back on central bank policy. Under no circumstances should the stop-go monetary policy of the 1970s be repeated. Even at the risk of overtaxing the economy, central banks will continue to systematically fight inflation by keeping interest rates high. In contrast to the last few quarters, however, policy is now being aimed at inflation on services more than on goods. For the risk markets this means that exceeding peak inflation will probably be supportive but, at the same time, growth concerns set limits on excessive increases in value. In consequence, what we take from this is that – unless we get further clarity on when the economic downturn will end – high volatility and equity markets that are likely to trend sideways is how things will stay. Thus, interesting possibilities should crop up now and again on the margins of expected price movements. Generally, however, it must be borne in mind that in view of the many stress factors, much has already been priced in, and positive surprises cannot be ruled out. In the bond segment, the situation is slightly different. Sharp increases in credit spreads and surprises on the interest-rate front give us a good deal of optimism for bonds as we start the new year. For this reason, we are starting with a neutral equity allocation of 18%, an expanding fixed income portfolio (64%, of which 46% sovereign bonds) and a USD allocation of 15% this year.

Fund positioning

Figure 5: Portfolio structure* of the Ethna-AKTIV

Figure 6: Portfolio composition of the Ethna-AKTIV by currency

Figure 7: Portfolio composition of the Ethna-AKTIV by country

Figure 8: Portfolio composition of the Ethna-AKTIV by issuer sector


Key points at a glance

  • 2022 was dominated by risks more than opportunities
  • Flexible active management paid off, fell short of its potential
  • 2023 offers a huge range of possible scenarios
  • Countercylicality probably has the most attractive risk/reward profile

31/12/2022 - Looking back, 2022 was marked by various challenges. There’s no doubt that, for capital markets, the return of inflation – much higher, broader and persistent than many expected – was the dominant theme. This led to a revaluation of almost all asset classes on the back of rising interest rates. This revaluation was most evident in the segments of the market that were most sensitive to interest rates and/or which had seen the greatest excesses beforehand. In some cases both applied, as was the case with unprofitable technology stocks, which, after the steep falls from their highs of 2021, again saw falls of more than 60% on average in 2022. But even the prices of bonds with strong credit ratings came under such pressure in 2022 from rising interest rates and yields that their negative performance was very much on a par with that of equities.

Within the Ethna-DYNAMISCH, we were very aware of the difficult situation regarding valuations at the start of the year. So we completed avoided investing in the bond market, as the yield of -0.18% on 10-year German Bunds and corporate bond credit spreads close to historic lows presented major risks effectively without any counterbalancing opportunities. The situation in the equity market was slightly more complex. Here, too, there were obvious excesses of which we steered well clear, but there was fluidity between various segments of the markets. In the first quarter in particular, we endured slightly greater falls in prices in many growth and quality stocks than average. Making a drastic cut by selling such exposed equities on the scale of 10% of the total fund volume in January helped to limit the fallout, but couldn’t avoid it entirely. Also, the alternative we took in some cases, to counter higher U.S. equity valuations with much more moderate valuations in Europe, proved not very helpful once the Russian invasion of Ukraine began. In the end, it was primarily the high cash allocation and the hedges we continually entered into that gave the fund some stability on occasion in these tough times.

Over the rest of the year, then, always these same stress factors – inflation, central bank policy, valuations, geopolitical tensions, fears of recession – were in constant rotation, and caused sometimes more sometimes less unease among investors. Only volatility in markets was constantly high. Against this backdrop, within the Ethna-DYNAMISCH we focused on a solid basis of attractive companies with structural growth, which we continually expanded, especially in the second half of the year, and also supplemented with a series of new individual names. In parallel, we managed the equity risk with the aid of the results of our regular and broad-based market analyses in the form of the tried-and-tested market balance sheets. While the overall outlook on the equity markets was characterised by restraint until very recently, there absolutely were promising signals – both upside and downside – at the tactical level. These were marked by periods of extremes in investor sentiment and in the positioning of certain investor groups. We jumped at some of the opportunities we identified by reversing or adding to the hedging components in the fund in a targeted manner. In retrospect, unfortunately, too often we did not have the element of luck also required to pull off such measures.

On balance, therefore, this led to only an average year considering the Ethna-DYNAMISCH’s aim and environment, although we could certainly have done better given the resources available to us. At the same time, we must remember that, overall, the downside risks in markets outweighed the potential opportunities last year, so, when in doubt we tended to opt sooner for the lower-risk option.

If we were to sum up the outlook on the year 2023 ahead in one word, it would be “diversity”. The range of possible and half-way realistic scenarios has seldom been greater than at the end of 2022. The dominant themes for the moment will not change with the turn of the year. Inflation, central bank policy, valuations, geopolitical tension and fears of recession will also shape the first few months of the new year. Not a single one of the (previous) challenges mentioned has been overcome yet. In the case of every single factor, it wouldn’t take too much imagination to picture a further escalation but, equally, a significant easing. With this it mind, there is little point in committing to a single scenario and positioning a portfolio accordingly.

Instead, in 2023, it will very much depend on which scenario will be priced in by market participants to what extent and at what point, and where individual attractive opportunities arise as a result. With a robust portfolio core – a portfolio of individual securities with attractive valuations, designed for sustainable growth – the potential for a successful year for active investors certainly exists, even if equity markets overall do not finish up 2023 with significant gains over the end of 2022.

The latest consensus among market participants on the outlook for 2023 was roughly as follows: the first half will be difficult but the second half will eventually see much change for the better. We again took tactical and countercyclical advantage of December’s correction associated with the subdued short- to medium-term outlook to reduce the hedges, bringing the net equity allocation at year-end to around 50% (versus 38% at the end of November).
“Do the opportunities in equity markets outweigh the risks?” Continually answering this question will again largely guide our positioning of the Ethna-DYNAMISCH in the new year – so that investors can sleep soundly while investing in equities, thanks to ETHENEA’s risk-controlled, equity-focused mixed fund.

Fund positioning

Figure 9: Portfolio structure* of the Ethna-DYNAMISCH

Figure 10: Portfolio composition of the Ethna-DYNAMISCH by currency

Figure 11: Portfolio composition of the Ethna-DYNAMISCH by country

Figure 12: Portfolio composition of the Ethna-DYNAMISCH by issuer sector

* “Cash” comprises term deposits, call money and current accounts/other accounts. “Equities net” comprises direct investments and exposure resulting from equity derivatives.

HESPER FUND – Global Solutions (*)

Das wichtigste auf einen Blick

Central banks surprised markets with a hawkish stance

  • In November, US inflation slowed for a second month in a row, the Fed downshifted to a half-point hike but warned of a higher peak rate.
  • The ECB step down to a half-point increase, but stunned the markets by indicating further significant rate hikes just when recession hits.
  • The Bank of Japan surprised markets with a change in its yield-curve control policy.
  • In a split vote, BoE raised interest rates by 0.5% to 3.5% but sent a dovish signal to the markets.
  • The global economy is slowing, but we see different inflation dynamics, labour market strengths and debt burdens across regions and countries.
  • Equities pulled back, and sovereign yields jumped higher as markets digested that monetary policies would remain tighter for longer and downside risks would grow significant.
  • HESPER FUND – Global Solutions continued its tactical retreat. The fund reduced duration to 1.7 years and decreased the net equity exposure to 11.8%. Short exposure to the British pound was increased to 6.3%.
  • The fund’s average USD exposure was further reduced from 9.5% to 4.5%

31.12.22 – Hopes of an end of Fed tightening coming soon vanished in mid-December despite good US inflation numbers.

In the U.S., Inflation decelerated again but Jay Powell reiterated his hawkish remarks indicating that the Fed funds terminal rate will likely be higher than previously expected, sending yields soaring.

In the Eurozone, the ECB policy approach became unexpectedly more aggressive. After months of hesitant policy normalization, Christine Lagarde pointed to further significant tightening at a steady pace because inflation is stubbornly high. The ECB hawkish speech surprised the market and gave some support to the euro. Yields in the Eurozone soared and spreads rose.

The BOJ`s decision to widen the trading range for 10-year bond yields triggered a jump in the yen that roiled global markets. Yields soared to 0.45% triggering an increase in global sovereign yields. Inflation in Japan jumped to a near 41-year high. Speculation increased about further changes in BOJ policy down the line.

Only in the UK, whose economy is already contracting, the BoE sent a dovish signal after a split decision on a 0.5% rate hike. Consumer confidence in the UK has remained near record lows for eight months, and inflation fell more than expected from its 41-year-high. Chronic labour shortages and strikes complicate a challenging environment for policymakers.

Differentiation between the main developed economies

The US economy is still resilient thanks to a tight labour market and healthy consumer spending. However, the aggressive Fed’s tightening of the last months is gaining traction with a weakening real estate market, and leading indicators and surveys of future activity pointing to a marked slowdown going forward. The policy front-loading has allowed the Fed to regain time and policy space, leaving the US central bank in a better position to control economic developments and inflation.

This is not the situation of the ECB and BOE, which are facing much higher inflation, weakening economies, energy shortages and a sharp decline in real consumer income. The macroeconomic policy mix poses a major challenge as fiscal stimulus challenges tighter monetary policy. Given the weakening economy, strong fiscal support and difficult policy environment, there is a risk that the ECB will not be able to tighten monetary policy sufficiently to prevent a damaging stagflation scenario.Against the backdrop of robust growth in the eurozone and a better global outlook, the EUR strengthened against the USD. To sustain the initial rebound (11% from its September lows) the EUR will need considerable help from inflation-adjusted rate differentials. It is by no means clear whether a possible further tightening of monetary policy by the ECB by 100 basis points will have a concrete impact on the improvement of the EUR outlook, as a stagnating and weakening economy could well weigh on euro performance again. Moreover, if inflation decelerates but remains well above the central bank target, European yields could remain high despite a weakening economy. This could hit government bonds in the eurozone periphery, such as Italy's BTP, particularly hard, as Italy will have to issue and roll over large volumes of bonds in 2023.

Rising yields killed the Christmas rally

Toward the end of the year, yields rose again and stocks reversed their rebound. In December, most stock markets declined as central banks disappointed market expectations of a quick end to the monetary tightening cycle. Chinese stocks were the exception as China confirmed the end of its zero-Covid policy to revive its economy. The Euro Stoxx 50 fell 4.3% (-0.6% in dollar) while the S&P 500 lost 0.8%. The DJIA rose 1.3%. The defensive Swiss market index fell 3.6% (-0.5% in dollar). The Nasdaq plunged 4.7%, the Nikkei dropped 6.7% (-1.9% in USD thanks to the strong appreciation of the yen) and the Kospi fell 9.6% (-5.8% in USD dollar). The rebound in Chinese stocks continued as China lifted Covid restrictions, reopening borders despite a rise in infections and heavily overloaded hospitals. The Hang Seng rose 6.4% and the Shanghai Shenzhen CSI 300 moved slightly forward by 0.5% (+2.7% in USD terms).

Positioning and monthly performance

The HESPER FUND – Global Solutions performed modestly during the month, as we recalibrated our tactical exposure to further changes with regard to the market sentiment. Uncertainty concerning growth and inflation remains high, and markets alternate between risk phases supported by disinflation and hopes of a soft landing, and corrections triggered by hawkish central banks and stagflation fears.

The T-6 EUR share class fell by 1.21% in December. Year to date, the fund is down -3.80%. Total assets continued to rise, reaching €81.96 million at the end of the month (an increase of €40 million over the year). The share is 6.73% below its all-time high of 29 September.

Volatility over the last 250 days decreased to 6.3%, retaining an attractive risk/return profile. The annualised return since inception fell to 5%.

As the new year begins, the fund continues to maintain a cautious stance and looks for opportunities with a balanced portfolio. On the currency front, the exposure of the HESPER FUND – Global Solutions is as follows: 4.5% in USD, 10.1 % in CHF and -6.3% in GBP.

The net equity exposure was reduced to 11.9% with the following regional blend: 3.9% DJIA; 1.8% S&P 500; 4.3% Switzerland and 1.9% Asian emerging markets. Duration was reduced to 1.7 years and credit risk maintained at negligible levels.

As always, we continue to monitor and calibrate the fund’s exposure to the various asset classes to adapt to market sentiment and changes in the macroeconomic baseline scenario. During the last year, geopolitical events played a decisive role in our asset allocation. A deglobalisation trend is clearly emerging, which may also well contribute to keep inflation high for longer. The end of loose monetary policy is the major event taking place.

Farewell to 2022: war, inflation and tumbling markets

We say goodbye to 2022, which undoubtedly proved to be one of the worst years for investors worldwide in recent decades. A year in which sky-high inflation, the war in Ukraine and aggressive central bank tightening reduced the value of global equity markets by a fifth in value and global bond markets by 16%. It was a historic year for central banks, which raised interest rates at the fastest pace since the 1980s to tame stubborn inflation that had reached its highest level in four decades. The end of the era of hyper-low or negative interest rates was a hard blow to markets. An unprecedented shift that leaves us in a very uncertain transition period.

Macro scenario of the HESPER FUND – Global Solutions

During the last few years, the global economy has suffered a number of major shocks that may have affected long-term dynamics and will require time to be fully absorbed. Our medium-term macro outlook assumes that the global economy will continue to weaken significantly, with inflation declining at the headline level but remaining well above central bank targets, and central banks maintaining their restrictive policies for 2023. This may lead to a few quarters of negative growth, followed by a weak economic expansion. A global recession is still likely, especially if the Chinese economy struggles to reopen and continues to drag down the global economic performance. This challenging macro scenario is compounded by several potential threats, including significant risks for financial stability, as continued policy tightening could rupture a weak link in the financial system. It is too early to say whether global economic slowdown will be resolved after a few quarters of negative growth. A harsher and longer recession is not foreseeable at present, as household and corporate balance sheets are healthy, but the scenario remains very uncertain and there are still considerable clouds on the horizon.

*HESPER FUND - Global Solutions is currently only authorised for distribution in Germany, Luxembourg, Italy, France, Austria and Switzerland.

Fund positioning

Figure 13: Equity exposure by region of the HESPER FUND − Global Solutions

Figure 14: Currency allocation of the HESPER FUND − Global Solutions

Figure 15: Bond rating structure of the HESPER FUND − Global Solutions

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The prospectus, the key information documents (PRIIPs-KIDs), and the Articles of Association, as well as the annual and semi-annual reports, can be obtained free of charge from the representative. Copyright © ETHENEA Independent Investors S.A. (2023). All rights reserved. Munsbach, 08/06/2021