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Portfolio Manager Update

To the latest Market Commentary

Ethna-DEFENSIV

Key points at a glance

  • The Ethna-DEFENSIV’s positioning remains conservative
  • Equity allocation still 0%
  • U.S. dollar exposure reduced from 10% to 0%, profits taken
  • Overweight in fail-safe investment grade bonds
  • Negative duration of -1.6, positive performance given rising interest rates

31 May 2022 - 10-year Treasury yields have been headed in one direction in recent months but this came to an end in May. 10-year U.S. Treasuries fell from 2.98% at the end of April to 2.73% at the end of May while German Bunds rose from 0.97% to 1.06%. The decline in yields in the U.S. is due for one to volatile equity markets and the ensuing flight to safe havens. For another, yields in the U.S. have climbed sharply since the beginning of the year and have already priced in a good deal of the Fed’s anticipated rate hike. In Europe, the rise in yields has so far been more modest. In particular given the high rates of inflation – which have now arrived with a bang in Europe as well, leading a few European monetary authorities to rethink their approach – going forward we expect yields to rise relatively sharply (i.e. a narrowing of spreads between Bund and Treasury yields).

Since the invasion of Ukraine, if not before, the narrative of inflation “temporarily” overshooting the ECB’s 2% target hardly stands up any longer as inflation has been well above this level for some time now. Whereas only a few months ago the expectation was that the first, cautious rate rise would come no earlier than the end of this year or the beginning of next year, now the market consensus is three rate hikes of 25 basis points each in July, September and December. It remains to be seen whether this is how things pan out. It is certainly conceivable that the central bank will capitulate after the first few hikes and shift back down a gear due to sharp rises in capital market interest rates in the highly indebted economies of southern Europe. However, at the moment the hawks calling for restrictive monetary policy to curb inflation are gaining the upper hand. Within the ECB ranks there are now even calls for much stricter monetary measures than the aforementioned. One proponent of such measures is Dutch central banker Klaas Knot. He recently called for the deposit rate to be raised in a single increment from the current rate of -0.5% to 0.0%; i.e. 50 basis points. Other proponents include Martins Kazaks from the Latvian central bank and Robert Holzmann from Austria, both of whom deem a much greater initial rate hike to be appropriate. Even dovish central bankers such as Christine Lagarde and Francois Villeroy are now in favour of higher interest rates – and that’s saying something. Calls for a more restrictive approach to combatting inflation are thus becoming more vehement; at the same time, political pressure is mounting. German Federal Minister of Finance Christian Lindner called the fight against inflation “a top priority” on 30 May 2022 and, at the same time, argued in favour of an end to expansionary financial policy. That said, our baseline scenario is still that the ECB will raise key rates bit by bit in 25-basis-point increments, especially since we expect it to let the asset purchase programme run out at the end of June. In the absence of asset purchases, the ECB will have little influence over sovereign bond yields. A rate hike well above market expectations could cause potentially huge upheaval in bond markets, especially in the southern EU countries, and make refinancing difficult for already highly indebted economies.

The U.S. Federal Reserve’s more decisive approach led to a sharp rise in the value of the U.S. dollar (+5.35% since the beginning of the year). We expect that the ECB will not be able to stand up to the Fed in the medium term and will at least have to increase interest rates gradually to prevent further loss of value of the euro and thus imported inflation on account of commodities priced in U.S. dollars. With this in mind, we completely closed our U.S. dollar position in May and took profits. At the same time, the absolute duration remains almost unchanged at -1.7 (which implies a potential positive performance given rising yields). However, we reduced our interest rate hedge on long-dated U.S. Treasuries, since (as mentioned above) we are of the opinion that we are over most of the yield movements in the U.S., while in Europe we see additional upside. On top of that, with sell-offs in equity markets, investors see U.S. Treasuries as favoured safe havens, which may lead, at least in the short term, to distinct falls in yields in the event of any jitters. The Ethna-DEFENSIV lost 0.1% in May. Risk premia for corporate bonds – which were down – and gains on the U.S. dollar position – now closed – made positive contributions to performance. Yields on U.S. dollar-denominated bonds were down, and the interest rate hedge was also a detractor. For the year to date, the fund stands at -3.02%.

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

Ethna-AKTIV

Key points at a glance

  • The Ethna-AKTIV’s positioning remains consistently defensive
  • Portfolio duration still negative
  • Despite strategic underweight, the equity portfolio contribution is positive thanks to selection and tactical allocation management
  • U.S. dollar exposure reduced to 0%

31 May 2022 - Our highly defensive positioning paid off in May as well. Not only was fluctuation in fund assets greatly reduced, but we also managed to increase fund assets in this challenging market environment. We have often mentioned here that it can take time especially to increase fund assets.

The Fed meeting at the beginning of the month was only good for a one-day rally in prices. The sell-off in risk assets continued for the rest of the month and led to new lows or, rather, new highs in volatility for the year for many indices. In contrast to previous months, however, a flight to sovereigns was seen for the first time during this period of stress, which in turn led to falls in interest rates. In terms of the reporting season just ended, reported revenues and earnings tended to be better than expected but the frequently very cautious outlook contributed to growing uncertainty among investors. In our view, central banks’ well-communicated policy on rate hikes has now been relatively well anticipated and priced in. This policy will very likely leave its mark on consumer spending and company margins, a fact that obviously only dawned on participants in the course of May. The uncertainty over the extent of this process of adjustment is what we believe led to the excess short-term downside. The strength of the countermovement in the last week of the month is both proof of this and also another sign that the bear market has not come to an end yet. This movement came amid unconvincing revenue, and such sharp movements in prices are almost only seen in bear markets.

Despite our continued scepticism about risk assets, we were able to benefit from the countermovement following the excess by quickly reversing all equity hedges. However, in the first week of June most of this equity exposure will again be hedged. We reduced the U.S. dollar allocation to zero in the course of the month. Firstly, we regard the strength of the U.S. dollar in the current growth and inflation environment to be at its limits around 1.05. For us to take up a positioning again, we would have to see lasting changes – either in the environment or the price. With no let-up in inflationary pressure and given the beginning of tapering in June, we expect interest rates to continue to climb both in the U.S. and in Europe. Accordingly, we brought the bond portfolio – which was very conservative as it was and also just short-dated – to a modified duration of -5.6 via the duration overlay. We reduced the interest rate sensitivity – which was even higher during the month – to a manageable level due to the attendant price volatility.

In summary, the summer months ahead will also be extremely volatile due to the high level of uncertainty about the processes of adjustment that are needed.

With our continued defensive positioning, we have thus created the basis, given the right signals, to take short-term opportunities again or to enable us to build up strategic exposure again.

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

Ethna-DYNAMISCH

Key points at a glance

  • In May, we counter-cyclically took advantage of the overselling and the extreme pessimism on the part of market participants to increase the equity allocation temporarily.
  • Despite that, there are numerous medium-term stress factors for equity markets.
  • Hence the continued low equity and high cash allocations.

31 May 2022 - Many of the factors weighing on the equity market at the moment are down to high inflation. Therefore, market participants were recently riveted to the publication of consumer and producer prices. The latest data points show that levels remain (in some cases surprisingly) high. Thus the pressure remains on central banks to tighten their monetary policy, which will have a negative effect on the absolute valuation of equities and lessen their attractiveness relative to fixed-income securities.

In addition, market participants were also focussed last month on the reporting season, which was coming to an end. This reinforced the picture we painted in last month’s commentary that while the first quarter was very solid, the outlook both for revenue and earnings is disappointing. Higher production costs are reducing profit margins and consumers are reining in their spending because inflation is eating into their real wealth. Indicative of current consumer restraint are reports from some retailers whose inventories have recently shot up due to slack demand. Also cost-cutting measures by businesses – recruitment freezes and advertising budget cuts – are down to the difficult economic environment.

In short, equity markets will continue to be impacted both by the monetary measures and developments in the real economy in the medium term. Based on this perspective, the Ethna-DYNAMISCH’s positioning in recent months was cautious with a net equity allocation of just under 30%.

We tactically pared back this positioning in mid-May, temporarily raising the net equity allocation to around 60% by reversing our hedges. The reasons for the counter-cyclical increase were the recent extremely pessimistic investor sentiment and a greatly oversold market.

This tactical move was based for one on our additional bottom-up analysis, which enabled us to identify a growing number of attractive candidates for investment. One of them – RingCentral, a U.S. software provider for cloud-based corporate communication with a market capitalisation of almost USD 6.3 billion – was added to the Ethna-DYNAMISCH portfolio with a small allocation of around 0.5% of the net asset value. The share price movement of RingCentral sums up the equity market mania during (and after) the COVID-19 pandemic. While the share price of this winner in the pandemic doubled between 2020 and 2021, the share is currently trading back at its 2018 level. We are of the opinion that both the rise and the fall were excessive. The fundamental development of the company, which has been listed since 2013 and is expected to be profitable this calendar year, remains unaffected by the share price troubles and is still going well. The combination of structural growth and a reasonable price make RingCentral a good addition to the Ethna-DYNAMISCH. We have further candidates for investment from diverse market segments on our watchlist and expect to open and add to further positions in the coming weeks and months.

Despite the fact that a number of individual names are attractive from a bottom-up perspective, the overall market environment, as described above, remains negative in the medium term. We will therefore counter-cyclically dial back the net equity allocation once again through hedging instruments. With a low equity allocation and a high cash position, we remain well equipped for what is expected to be a volatile market environment.

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 (*)

Key points at a glance

  • As inflation bites and central banks move to aggressively tighten monetary policy, worries about the resilience of global growth are escalating.
  • Euro-area consumer prices accelerate in May to an all-time high of 8.1% y/y
  • Policy divergence remains a key driver for currencies in the short term.
  • The threat of recession is looming over Europe’s fragile economic growth.
  • The equity exposure of the HESPER FUND – Global Solutions was further reduced and turned negative.
  • The fund’s exposure to the USD was reduced as the greenback softened on weaker US data and hawkish ECB forward guidance.

31 May 2022 - The war in Ukraine and the subsequent sanctions are responsible for a further significant jump in inflation around the world, as the cost of energy, food, and raw materials continue to soar. As the war continues and new sanctions are imposed, the economic damage is spreading. Europe looks most at risk of recession, but the US economy is also showing signs of softening momentum. Chinese growth remains in contractionary territory in May as the government sticks to its zero-Covid policies and despite a batch of new measures aimed at boosting spending and fostering economic growth. There are increasing worries that trade-dependent and commodity-importing emerging economies, facing commodity shortages and a strong USD, will soon be confronted with an economic crisis. Sri Lanka has defaulted on its debt and Egypt was forced to ask for IMF support.

During the last week of May, we observed however a significant improvement in market sentiment as yields stabilised and the dollar retreated. Investors may start to factor in the chance that, confronted with a slowing economy, the Fed may decide to back off from the aggressive tightening path discounted by the markets. Moreover, the euro strengthened as the ECB clearly indicated that negative rates would soon be a thing of the past and that it would start its tightening cycle as early as July. All this helped to temper the strength of the dollar and credit risk around the world. Battered stock markets bounced back and cut losses for the month and the dollar-denominated emerging market debt partially recovered. Thus, a risk-on rally in the second part of the month helped to reduce year-to-date losses for the equity markets. However, we believe that the outlook for the global economy and for companies’ earnings remains very uncertain if not gloomy. Stagflation remains the most likely scenario for several countries. Inflation remained elevated globally in May and continued to accelerate in the euro area where it reached a further all-time high of 8.1% y/y. The price of Brent oil touched USD 125 per barrel as the EU finally agreed to ban most Russian oil imports, paving the way for the sixth package of sanctions but also damaging the prospect for growth in the coming quarters. The foundations for the recent risk-on rally continue to look shaky to us.

In May, US equity markets first plunged to touch year lows and then recovered, as yields stabilised at a lower level, but closed the month on a weak note. Over the month, the S&P 500 remained unchanged (+0.04%). The Dow Jones was also flat (+0.01%). The Nasdaq Composite continued its bear market run despite some sharp intermonth bounces, tumbling by 2.1%. The small-cap Russell 2000 Index was also unchanged during the month. In Canada, the S&P Toronto Stock exchange ended flat, falling by 0.2% (+1.3% in USD terms).

In Europe, stocks pared losses during the second part of the month. The large-cap Euro Stoxx 50 Index decreased by 0.4% (an increase of 1.5% when calculated in USD) while, in the UK, the FTSE 100 rose by 0.8% (+1.3% in USD). The defensive Swiss Market Index plunged by 4.3% (-2.7% in US dollar terms) over the month.

Asian equity market performance in May was mixed. Chinese equities recovered from their lows as the government unveiled several expansionary policies and Covid curbs eased. The Shanghai Shenzhen CSI 300 Index rose by 1.9% (+1.6% in USD terms) and the Hang Seng Index gained 1.1%. In Japan, the blue-chip Nikkei 225 rose by 1.6% (+4% in USD terms, due to the rebound of the yen). In South Korea, the KOSPI Index fell by 0.3% (+1.5% in dollar terms). India’s BSE Sensex stock market declined by 2.6% (-4.1% in USD terms). The Australian stock market plunged 3% (it lost 2.6% in USD terms).

So far, the HESPER FUND – Global Solutions has been able to manage this very uncertain and challenging environment and to shrug off the main shocks. The ongoing conflict in Ukraine, combined with the increase in Covid-19 cases in China, have changed our macro scenario for 2022. Economic growth will be considerably slower and inflation will be higher and more persistent than previously expected. Most central banks have made combatting inflation their absolute priority and are progressively tightening their policies. At this point, with inflation still accelerating, it is too early to say whether central banks will be able to achieve a soft landing or end up pushing their economies back into recession. Recessionary risks have however increased considerably.

While the economic scenario is heterogeneous across regions, the risk of policy misstep is now particularly high. With countries at different stages of the economic cycle and affected to differing degrees by the war in Ukraine, we are likely to see increasing policy divergences that will affect the relative performance of countries and regions and provide trading opportunities for the HESPER Fund – Global Solutions.

The HESPER Fund – Global Solutions has further reduced its equity exposure to the point that it has turned net short. During the second half of May, the fund suffered as stocks bounced back and the dollar retreated. Stop limits were triggered for the dollar, thus trimming the dollar exposure from 40% to 10%. The fund has kept a net short exposure to equities of 11.3% as we think risks for the equity markets are still tilted to the downside. In terms of duration, for most of the month we had a net duration of zero or even slightly negative. Exposure to HY corporate bonds has been diluted to 6%. The fund took profits and closed its exposure to the Mexican peso.

As we head into June, the fund is maintaining a very cautious stance. On the currency front, the HESPER FUND – Global Solutions has the following exposure: 10.3% to the US dollar, 10.3% to the Swiss franc and 7% to the Canadian dollar. In addition, it is short 9% against the pound sterling.

As always, we continue to monitor and calibrate the fund’s exposure to the various asset classes on an ongoing basis to adapt to market sentiment and changes in the macroeconomic baseline scenario. During the last four months, geopolitical events also played a decisive role in our asset allocation.

The HESPER FUND - Global Solutions EUR T-6 decreased by 1.82%. YTD the fund stands at -1.14%. Volatility for the last 250 days has remained stable at 6.7%, retaining an interesting risk/return profile. The annualised return since inception is at 7.41%.

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

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The prospectus, the Key Investor Information Document (KIID), 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. (2022) All rights reserved. Munsbach, 08/06/2021