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Your questions, our answers

In our latest issue of Clear and Simple, our Portfolio Managers discuss whether, after the election of Joe Biden as US President, we will see an easing or escalation in US-Chinese tensions, the potential for a year-end rally, as well as whether or not the ECB and the Fed are likely to tighten their respective monetary policies. They also look at the significance of long-term asset allocation versus single stock selection and discuss the likelihood of a rotation from the growth to the value segment.

Following Joe Biden’s election as US President, will the current tensions between the US and China ease or escalate? Is there any risk that the situation will weaken the global economy even further?

The tensions between the US and China, as well as the increase in trade tariffs, have posed major problems for the global economy since 2018. Not only have they reduced growth in the US and China, they have also impacted global growth by disrupting value chains worldwide. An escalation in this situation, which is not currently anticipated, would certainly put a strain on the weak and uncertain global recovery in 2021.

Going forward, we expect the administration of President-elect, Joe Biden, to take a more moderate and less confrontational approach to international relations. However, as the opposition to China’s expansionism has been one of the few (if not the only) issues to receive bipartisan support in the US Congress, we do not expect to see any significant change in US attitudes towards China, at least in the short term. The Biden administration is likely to opt for a multilateral approach and refrain from bipartisan and unpredictable actions against China, However, it will not be able to easily reverse the course of action initiated by the Trump administration.

For the majority of market participants, an end to Trump’s at times erratic and impulsive politics will primarily mean less volatility and more planning security. The change in administration has no direct impact on the positioning of the Ethna Funds, particularly with regard to this issue, as the tendency towards similar policies means that no changes are necessary.

Do you believe that there will be a year-end rally this year? If so, would the Ethna-AKTIV benefit from it or is the portfolio too defensively positioned for that?

In our view, conditions are in place for a positive market over the next three to six months. However, no-one knows whether this will be reflected in rising prices at the end of the year.

The uncertainty surrounding the US election has been eliminated. A Democratic President who is likely to have a divided House will not be able to change either the tax system or the regulatory framework. Moreover, with the prospect of an effective vaccine being available in 2021, many market participants are prepared to look beyond the current pandemic situation and the lockdown measures that have been implemented. With the backing of a still very supportive central bank policy and other fiscal packages, companies’ earnings prospects should not only stabilise next year, but may even provide positive surprises.

Despite the already technically overbought situation, we have moved our tactical neutral exposure to an overweight position due to the fact that a vaccine is expected to be available in the near future. Accordingly, the current portfolio composition is by no means too defensive, but rather balanced and well positioned, in particular on the equity side with a mix of technology stocks and attractive cyclicals. In our view, the technical and sentiment-driven exaggerations will subside over time. “Buy the dip” is once again the maxim.

The low interest rate phase is a dominant factor over the long term. In light of this, what is the significance of long-term asset allocation as opposed to single stock selection?

Both approaches serve as sources of alpha in performance generation. It is important to note that they are not in competition with each other, but can be used in parallel. Within the Ethna-AKTIV, we use the flexibility available to us and make use of our expertise in both areas.

However, it goes without saying that strategic asset allocation has by far the greatest leverage and is the more effective instrument for generating attractive risk-adjusted returns over the long term. If, as is the case with the Ethna-AKTIV, the aim is to generate these returns with a manageable level of risk, it is essential to adopt a strategic asset allocation approach. Firstly, only a reallocation to low-risk or even risk-free assets can reliably protect the fund assets from heavy losses during stress phases. Secondly, the use of different asset classes in the strategic asset allocation offers greater diversification potential than simply selecting within one asset class.

Do you expect that the ECB and the Fed will tighten their respective monetary policies and start selling bonds?

During its meeting at the end of October, the ECB clearly stated that it had no intention of becoming more restrictive. Purchases made under its temporary Pandemic Emergency Purchase Programme (PEPP) will continue until at least June 2021. Principal payments from maturing securities will be reinvested in bonds until at least June 2022. The smaller asset purchase programmes (known as APP in ECB terminology) will even continue until the central bank measures take place and inflation moves closer to target levels. The ECB has also announced additional measures, which will be adopted as early as December. This makes it clear that the ECB will remain a bond purchaser for at least the next 18 months and has no intention of selling bonds. The ECB will not achieve a reduction in its bond holdings by selling bonds, but by phasing out its existing investments. The same applies to the Federal Reserve. In the US, discussions about additional government spending to revive the US economy are in full swing. As far as refinancing is concerned, the Federal Reserve is likely to step up its purchases of US Treasuries again.

For this reason, bonds – with a weighting of more than 85% - remain the first choice for the conservative Ethna-DEFENSIV, as they continue to offer a moderately positive performance with low volatility. On the other hand, in the Ethna-AKTIV, which has a less conservative profile, we have reduced the bond component and invested the released capital in equities. This is not because of any lack of confidence in bonds, but from the perspective that continued low interest rates will give a further boost to equity performance, particularly in growth stocks. Furthermore, the Ethna-AKTIV is able to tolerate higher volatility if the return prospects are correspondingly high.

In your opinion, how likely is it that we will see a rotation from the growth to the value segment in 2021? How sustainable would this rotation be in the long run?

Since approximately 2007, we have been continuously experiencing better performance of fast-growing growth stocks compared to low-rated value stocks. This divergent development has even accelerated over the last three years – extremely so in 2020.

To pre-empt the second question: anyone who assumes that we will experience a sustained reversal of the aforementioned trend over the next few years must be disappointed at this juncture. By definition, value stocks are characterised by a low valuation. The capital market is for the most part efficient – so nothing is inexpensive without a reason. There are three main reasons for the low valuation of companies from the value camp. On the one hand, there is a lack of structural growth. On the other hand, they are confronted with new, disruptive competitors who are aggressively gaining market share and are constantly being supplied with fresh capital. In addition, low interest rates also put pressure on the valuation of value stocks. We do not expect any of the three factors mentioned to result in a sustained change in favour of value stocks in the foreseeable future. Therefore, in absolute terms, the medium to long-term prospects of many value stocks can be classified as rather modest. Over the longer term, the fundamental growth of companies remains a decisive and necessary (!) factor for a sustained positive share performance.

If, on the other hand, we focus on a short-term perspective for the coming year, we are currently starting from an extremely exhausted situation with regard to the relative developments of both equity styles. In particular, temporary effects triggered by the current pandemic seem to have been extrapolated too far and too uncritically into the future post-Covid world. The past few weeks with positive vaccine announcements have shown investors that even the outperformance of growth stocks versus value stocks is not a one-way street. By Spring 2021 at the latest, a normalisation of our social and community life – thanks to medical progress and the approaching summer – will become more perceptible, tangible and lasting. Coupled with a cyclical upswing, low comparative figures from 2020 and growing uncertainty about the continuation of the extremely accommodative monetary policy, the hitherto very one-sided positioning of many investors could be put to the test.

Fortunately, the equity market is not just made up of black and white - value and growth - but offers a variety of relevant shades and influencing factors. With this in mind, we have successively shifted the focus of the Ethna-DYNAMISCH equity portfolio from defensive stocks to more cyclical stocks since the lows in March. We have also taken profits from short-term winners of the crisis and invested more heavily in companies which, while experiencing the effects of the lockdowns in the short term, continue to show convincing structural growth over the long term. We currently see this as a compelling combination of attractive valuations and fundamental growth.

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