Portfolio Manager Update
Key points at a glance
- September: a month of interest rate hikes
- Conservative positioning has proven successful
- Yields are getting back to an interesting level for investors
30 September 2022 - Almost every central bank significantly raised its key rates in September. The global battle against inflation is in full swing. But can the battle be won? It is the very least that is required to trigger a decline in inflation. We are already seeing the cost of credit, especially for real estate, climb much higher. No doubt this will curb demand in the private economy.
But central bank policy is not a panacea. Energy prices depend for instance on global supply, embargoes and production curbs, and even the weather. Also, state aid programmes put in place to cushion the blow assuredly do exactly the opposite of what central bank policy is striving for, and promote unchecked energy consumption and demand on the part of the consumer. Furthermore, governments were at least able in recent months to affordably refinance their additional spending. However, this scenario is slowly coming to an end.
Things really kicked off in the UK. Reacting to additional spending and generous tax cuts by the Truss government, the value of the pound fell sharply and the yields on British 10-year gilts rose by 100 basis points to 4.5% in the space of three days. The Bank of England subsequently felt compelled to postpone its plans to reduce its balance sheet and even resumed bond buying. Yields dropped back by 50 basis points on the following day. 30-year sovereign bond yields fluctuated even more wildly: increasing by 150 basis points then falling by 100 basis – in a single day! It remains to be seen whether the Bank of England will help the government to pursue its debt policy or go on a collision course.
In any case, this episode has shown that debt sustainability is once again moving to the forefront of investors’ minds. The upshot was that the, in some cases sharply, inverted yield curves reversed towards the end of September and yields on long-dated sovereign bonds in particular increased sharply.
What does this mean for the Ethna-DEFENSIV?
Even though it wasn’t enough for a positive performance for the month, the extremely conservative positioning once again proved successful. We remain confident of bond investments in high-quality sovereign and corporate bonds with a short residual maturity and an average duration of three years. In addition, we hedge the portfolio against further yield increases using interest rate futures. We remain invested in foreign currencies – especially USD and CHF – which also shored up performance in September. However, we are slowly scaling back our USD allocation, as the U.S. dollar should stop strengthening soon (at least temporarily).
Speaking of the U.S. dollar and the Fed, we believe that what happens with inflation in the U.S. and the Fed’s central bank policy will be a deciding factor in the global performance of the economy and the capital markets going forward. If the Fed does announce a further 125 basis-point interest rate increase by the end of the year and score a win in the battle against inflation then the U.S. would probably achieve a soft landing. However, if the Fed is compelled to continue to increase interest rates in 2023 or to halt its hiking cycle prematurely because global financial markets cannot handle the current interest rate policy then we are facing more unsettled times.
In spite of everything, yields in the global bond markets have re-attained interesting levels for investors. Choice has returned to the bond market. 2023 will not be a repeat of 2022 where we’ve seen share price losses of 20% on average.
Key points at a glance
- Against the backdrop of new lows for the year in all asset classes, the Ethna-AKTIV’s conservative investment policy has paid off
- While the equity exposure is back to 0%, profits were taken on both the currency and the duration positioning
- The foreign currency weighting is currently 21% (USD: 15%, CHF: 6%); modified duration -0.3%
30 September 2022 - September has once again lived up to its reputation as a difficult trading month. The summer slump is most assuredly behind us. Events came thick and fast last month. It is well known that the central banks – especially the Fed and the ECB – are bent on combatting inflation at the risk of slowing growth. Both central bank chiefs have reiterated this in strong terms in their meetings. So it’s no wonder that the pace of increase in global interest rates picked up again. Then against the backdrop of restrictive monetary policy, one week after hiking interest rates the Bank of England was compelled to stabilise the UK sovereign bond market by buying bonds. Understandable from a populist point of view, but questionable from an economic perspective, the newly elected Prime Minister plunged the gilt market into crisis mode by announcing a programme of tax cuts for a budget that is already in deep deficit and plagued by double-digit inflation. Forced liquidations and possible domino effects on other markets could have caused a European Lehman moment here.
The Bank of Japan, too, was not idle. After the rapid fall in the value of its currency – triggered partly by rigorously adhering to its yield curve control strategy – it felt compelled for the first time in 20 years to intervene in the currency market to strengthen the yen. The combination of these monetary measures alone caused volatility in the markets to increase. There were also geopolitical developments that did prices no favours. Further adding to the negative picture is Russia’s reaction to how the war has gone and to the territorial gains by Ukraine by mobilising more troops and increasing arms spending.
The combination of these developments, including what is still very high inflation, is not a good sign for the coming reporting season. Fedex, Adobe and Google, for instance, are warning of sharp decreases in both sales and earnings.
In this environment of ongoing high volatility and new lows for the year for equities, bonds and commodities, the Ethna-AKTIV fared very well. The equity allocation built up during the bear market rally was quickly liquidated. The positions both in currencies and in the duration overlay were spot on. However, we switched to reducing exposure and taking profit here too. The U.S. dollar allocation was reduced to 15% over the course of the month. As a result of the shift in sold interest rate futures onto the five-year point in the curve, the fund’s duration of close to zero is now neutral with regard to interest rate movements.
Given our year-to-date performance and, in particular, by avoiding higher losses, we have done the groundwork and created the operational flexibility to be adequately able to take opportunities that arise.
Key points at a glance
- Many equity indices hit new lows for the year in September
- With its defensive positioning, the Ethna-DYNAMISCH was well positioned for just such an environment
- Despite our strategic restraint, we are laying the foundations to achieve more attractive returns in the future by cautiously building up and expanding individual securities
30 September 2022 - Not only is summer over, but so too is the bear market rally. Hopes that the interest rate hiking cycle would soon come to an end in light of slowing inflation were dashed. This realisation came firstly on the back of Jerome Powell’s speech at the U.S. central bank meeting in Jackson Hole at the end of August. In his eight-minute speech, the Fed Chair made it abundantly clear that the restrictive monetary policy was not going to be loosened prematurely – at the expense of economic growth. Secondly, the U.S. inflation data published mid-September – which turned out to be higher than expected – underscored that market participants’ expectations of a let-up in inflation and interest rate movements were overhasty. Also, further escalation of the war in Ukraine by Russia’s partial mobilisation of troops and the suspected sabotage of gas pipelines in the Baltic Sea impacted markets. Under these circumstances, many equity indices hit new lows for the year in September.
Our defensive positioning – net equity allocation of around 30% as well as 67% cash and cash equivalents – meant the Ethna-DYNAMISCH was well positioned to perform in this environment. Our restraint is motivated by the aforementioned headwinds, as well as the additional potential for downside arising out of the (ongoing) normalisation of margins and valuations in the current difficult economic environment. Numerous profit warnings have lately made it clear that companies are feeling the economic risks with a certain time lag. Based on this top-down perspective, we will continue to exercise caution and keep our net equity allocation low(er) (by using derivatives). In the current market environment cash truly is king.
At the same time, we realise that it is at such turbulent times in the market that the foundation for re-attaining much more attractive returns in future is laid. From a bottom-up perspective, we are actually seeing more and more companies on our watchlists that are getting more attractive. For this reason, we are carefully starting to build up new positions, “carefully” (still) being the operative word due our strategic restraint. One recent case is PayPal, the payment provider, which is a good example of our investment focus on “growth at a reasonable price”. PayPal’s valuation, which was excessive in the pandemic era has more than returned to normal in the meantime while its fundamental growth has continued despite the ups and downs in the valuation. In addition to its structural growth trend, its relative cheapness and its healthy balance sheet, the company’s short-term catalysts, such as the share buyback programme and the cost control initiatives (triggered for one by the involvement of an activist investor) persuaded us to open a position.
Developments on the currency front show how rapid and volatile movements are in capital markets at present. In August, we had raised the USD allocation from 25% to 35%. Back in September we successively pared this back again to 20%, as movement had again picked up in the meantime and, at its peak, the U.S. dollar gained 10% against the euro in the third quarter alone. We still consider tending towards countercyclicality to be the appropriate course of action in this regard, especially as the ECB is being much more decisive in fighting inflation.
All in all, companies and investors continue to face a very challenging market environment. The Ethna-DYNAMISCH, with the instruments it needs and its active management style, is well placed to continue to offer risk-controlled access to the equity markets.
* “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
Traumatic farewell to sub-zero rates and “low-for-long” rates
- Despite signs of economic slowdown, core inflation remains sticky
- Monetary authorities remain firmly on a tightening mission
- Global markets are confronted with the end of easy monetary policy. The bond rout and stock plunge hit markets severely, wiping trillions
- The dollar rose as risk off-mood intensified. Volatility among major currencies spiked, with the GBP under the spotlight
- Truss’ economic plan sent UK markets into meltdown. The pound and gilts were under siege as the new government unveiled a controversial fiscal plan
- The net equity exposure of the HESPER FUND – Global Solutions remained negative in September and overall duration including derivatives was negative for most of the month
- The fund’s average exposure to the USD remained around 25%, as the greenback continues to benefit from weak global economic prospects
- Short exposure to the British pound finally paid off.
30 September 2022 - Despite the economic slowdown, high inflation is not easing as expected or desired and most central banks remain on their path of aggressive tightening. The last round of rate hikes left no negative rates, signalling the end of an era.
In the US, a tight labour market and still healthy consumer spending sustain the Fed’s stance to keep hiking rates. Over the months, Jerome Powell reiterated that the Fed is determined to fight inflation and will continue to tighten policy until there are further clear signs that US core inflation is slowing. As a result, the dollar continues to strengthen and is weighing on many markets and economies.
September has been a hectic month with extremely high volatility in the bond, equity and forex markets. The bond rout will be remembered for years to come. Last Wednesday, the markets were roiled, when the US 10-year bond yield briefly exceeded 4% and UK gilt prices cratered. Measured by the Bloomberg Aggregate Index, investment grade bonds fell 5.2% in dollar terms in September and 20% over the past year.
Liz Truss became the fourth Tory leader in just six years. The new prime minister was greeted by a souring economy and surging energy costs. She decided to take a bold step and launched an aggressive fiscal plan to boost economic growth. The UK’s biggest tax cut in 50 years and huge energy expenses to support households and companies were too much for the gilt market, driving up yields and sending the pound to an all-time low. The carnage in the gilt market and the associated risks to financial stability prompted the Bank of England to change course by postponing quantitative tightening and announcing the temporary purchase of an unlimited amount of long-dated gilts. The market eventually stabilised and the pound pared losses. However, UK yields are now higher than in the US and the credibility of the UK authorities has suffered greatly.
It was bad month and bad quarter for equity markets, and indeed the third bad quarter in a row in what has been a dismal year so far. High inflation, higher yields and the clear hawkish stance of the Fed and other major central banks around the world have sent equity markets further down into the bear market.
Over the month, the S&P 500 dropped 9.5%, the Dow Jones plunged 8.8%, the Nasdaq Composite slumped 10.5% and the small-cap Russell 2000 Index fell by 9.7%, whilst in Canada, the S&P Toronto Stock exchange decreased by 4.6% (-9.4% in USD).
European equity markets sank as well. The large-cap Euro Stoxx 50 Index slumped 5.7% (a decrease of 8.1% when calculated in USD), while the UK’s FTSE 100 fell by 5.4% (-9.6% in USD). The defensive Swiss Market Index decreased by 5.4% (-6.4% in USD).
In Asia, equity markets cratered. Chinese equities suffered from a stagnant economy and ailing property market. The Shanghai Shenzhen CSI 300 Index fell by 6.7% (-9.4% in USD) and the Hang Seng Index plunged 13.7% to its lowest valuation on record. In Japan, the blue-chip Nikkei 225 decreased by 7.7% (-11.4% in USD, due to the depreciation of the yen). In South Korea, the KOSPI Index slumped 12.8% (-18.3% in USD). India’s BSE Sensex stock market decreased by 3.5% (-5.7% in USD). The Australian stock market fell by 7.3% (a loss of 12.2% in USD).
Once again, the HESPER FUND – Global Solutions has skilfully navigated this very uncertain and challenging environment and shrugged off the impact of geopolitical and economic shocks. The end of hyper-low rates is causing strong movement in the capital markets. The crash in bond prices was offset by shorting future contracts on 10-year Treasuries and bonds but mainly BTPs and gilts. On the currency front, Hesper remained long in USD and CHF and short in GBP. Regarding equities, the fund kept a small net short exposure for most of the month. As a result, the fund had a positive return in a very difficult month.
The ongoing war in Ukraine and the increase in COVID-19 cases in China have caused major negative shocks to both supply and demand, progressively changing the macro scenario for 2022. Economic growth will slow considerably, and inflation will remain higher and more persistent than previously expected.
A month ago, our recessionary positioning was not in line with an optimistic market environment, which continued to hope for a soft landing until the meeting of central bankers in Jackson Hole and the release of preliminary Eurozone inflation data for August. Recent developments throughout September have reinforced our macroeconomic view that a soft landing is becoming increasingly complicated. However, sharp price movements may lead to some price reversals, thus motivating the reduction of the fund's exposure to some directional bets for tactical reasons.
With inflation remaining high and the risk of losing control of inflation expectations, most central banks will continue to fight against inflation and a recession appears increasingly likely. The global environment remains fragile, but it seems clear that central banks have decided to keep tightening their policies until something happens or they succeed in bringing inflation under control. It is uncertain how resilient the global economy will be and how long the current period of stagflation will last. However, in a scenario of decade-high inflation, slowing growth and aggressive monetary tightening, the risks of recession have increased considerably. While we are observing a synchronized global slowdown and policy tightening, growth prospects and inflation dynamics vary across regions and countries, providing investment opportunities for the HESPER FUND – Global Solutions.
The net equity exposure of the HESPER FUND – Global Solutions was negative throughout September (-17.7% at the end of the month) as we consider that risks for equity markets are still tilted to the downside despite a hefty correction. High yield spreads have continued to widen (approaching recession pricing levels) and still call for a cautious approach to equity exposure. A number of market situations (policy missteps in the UK, Japanese currency market interventions and bond investments abroad, Chinese property market woes, Turkish bonds, Hong Kong dollar, tightening of Argentina’s foreign reserves, deteriorating economic outlook in Pakistan) indicate that tensions remain extremely high. Thus, we still expect equities to face headwinds.
The HESPER FUND – Global Solutions reduced its overall duration exposure turning negative from a certain point. At a high of -1.8 years, it was slightly negative at the end of the month, at -0.6 as we reduced leverage. The exposure to high yield corporate bonds has gradually been reduced further to just over 2%. We have continued to focus on the currency markets to achieve performance by taking advantage of asynchronous cycles and diverging policies. As sentiment darkened again and recession fears emerged, we maintained our high USD exposure as well as long exposures to other safe haven currency such as the CHF for most of the month. The fund has now traded the pound short against the CHF for several months and ended the month with an exposure of -8.5%.
As we have written in previous updates, Europe’s fragile economic growth faces a daunting challenge as the ECB hiked interest rates again in September amid a slowing economy and risks of market fragmentation.
As we head into October, the fund continues to maintain a cautious stance. On the currency front, the HESPER FUND – Global Solutions has the following exposure: 24.9% in USD, 24.7% in CHF and -8.5% in GBP.
As always, we continuously monitor and calibrate the fund’s exposure to the various asset classes to adapt to market sentiment and changes in the macroeconomic baseline. Over the past eight months, geopolitical events have also played a decisive role in our asset allocation. A de-globalisation trend is clearly emerging, which may also contribute to keeping inflation higher for longer. The end of easy monetary policy is the most important event currently taking place.
In September, the HESPER FUND - Global Solutions EUR T-6 increased by 1.93% in a very difficult environment not seen for a long time. YTD the fund is +2.62% and over 1 year +7.85%. Total assets reached a new high of EUR 72.4 million at the end of the month. Volatility for the last 250 days was slightly higher at 6.9%, retaining an attractive risk/return profile. The annualised return since inception is 7.43%.
* HESPER FUND – Global Solutions is currently only available in Germany, Luxembourg, Italy, France, Austria and Switzerland
Please contact us at any time if you have questions or suggestions.
ETHENEA Independent Investors S.A.
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