Commentary Categories: PROGRESSIVE GROWTH

What a difference a month makes.

After January’s spectacular start, investor optimism was tempered in February as, having eschewed reassessing assumptions based on more positive economic data, investors were forced to take note of the reacceleration in core inflation numbers and reassess where both the peak rate of interest lies and how long rates may remain elevated relative to the ultra-low levels they have become accustomed to in the post-GFC world.

That reassessment of how close to the end of the global tightening cycle we lie caused global equities and bonds to sell-off in tandem once more. Chinese equities were particularly poor performers, after a strong start to the year, as geopolitical tensions overshadowed the continued reopening as various ‘spy balloons’ found their way onto foreign shores.

The Fund returned -0.4% in February.

Two investments observed during the month with one of those investments maturing.

The maturing investment, which was linked to the FTSE 100 & EuroStoxx 50, called at the end of the first year of its life, paying out its full return of 7.7%. The proceeds were reinvested in an investment linked to the Nikkei 225 & EuroStoxx 50, with an annual return of 8.9%, illustrating that terms remain attractive against the environment into which the Fund launched.

The opportunity was also taken to upsize positions with attractive GRYs on the back of inflows.

There is currently over 34% on average before capital is at risk, and over 32% before investments would not pay out their full growth amounts, unchanged from last month.

The Fund’s GRY increased to 10.4% in the event that the underlying equities are flat, and the Fund retains large amounts of intrinsic value.

Of the three scenarios that could play out this year:

• Soft landing (& now ‘no landing’)
• Hard landing
• Higher for longer

The market was increasingly confident at the start of the year that no landing, or at worst a soft landing, had been orchestrated simultaneously with inflation making its way back to target largely by supply chain easing given Fed policy cannot be overly restrictive without some form of landing.

However, recent data has called this assumption into question. For the first time in a long time, central banks have replenished some of the arrows in their quivers to tackle a recession as and when that happens. The idea that there would be a pivot and those arrows would be used before any landing is in sight is fanciful. Investors must get used to the fact that ‘higher for longer’ is likely to remain in place until either inflation does come back down to target, which is likely to prove difficult (ceteris paribus) given structural shifts in economies, or the Fed tighten enough to break something, as they always do. Either way, we are comforted by the protection afforded to investors in the Fund, and the significant returns it can produce in an environment in which equity struggles.

What a difference a year makes.

2023 started in fairly spectacular style as risk assets across the board enjoyed a month of high optimism and returns.

December’s inflation numbers continued to slow whereas data turned more positive causing investors to assign a higher probability to a soft landing, and the whispers are now that a recession may even be avoided altogether.

The Fund had a similarly buoyant month, increasing by 5.1%.

Within the Fund’s underlying indices themselves, the reversal of a trend that characterised 2022 was of some note; the FTSE 100 Equal Weight Index, that lagged its market cap weighted sibling so significantly in 2022, outperformed as markets priced in the prospect of lower rates. On the other side of the world the Hang Seng, which was the subject of a number of issues topped by the ill-advised and fundamentally unachievable ‘zero Covid’ policy, has enjoyed a period of significant growth as it has become clear that Beijing have abandoned it entirely and will allow Omicron to blow through the population and reopen in earnest.

There were four observations during the month, with one investment calling.

The maturing investment, which was linked to the FTSE 100 & EuroStoxx 50, called at the end of the third year of its life, paying out its full return of 21.3% (7.1% x 3). The proceeds were reinvested in an investment linked to the Russell 2000 & EuroStoxx 50, with an annual return of 9.0%, illustrating that terms remain attractive against the environment into which the Fund launched.

Also of note is the increase in the protection levels afforded to investors after the recent rally. There is currently over 34% on average before capital is at risk, and over 32% before investments would not pay out their full growth amounts.

Despite the levels of protection increasing significantly, the Fund retains a high GRY of 9.9% in the event markets return nothing, whilst if markets were to fall 20% from here, the terminal payoff of the existing investments is +34.5%. Those returns are contractually stipulated and in effect locked-in provided the underlying indices satisfy their conservative final barriers.

The market is increasingly confident that the Federal reserve have managed to orchestrate a soft landing. Whilst this might be the case, purely on the balance of probabilities it is less likely than the other outcomes of a hard landing or the need for higher rates for longer. Anecdotally, they have never in their history managed it before. Investors should note that in all previous rate rise cycles, soft landing type conditions have been experienced, after all, you need to at least pass through those types of conditions before heading elsewhere. Let us hope we have reached our final destination.

Despite another month in which inflation numbers moderated, risk assets struggled as central banks reiterated their hawkish rhetoric and commitment to staying the course in taming inflation, which remains highly elevated. This was possibly best illustrated by the dot plot increasing in spite of the softer print.

Elsewhere, the big news came out of Asia, where China stepped up their relaxation of Covid curbs and Japan adjusted Yield Curve Control, widening the target band to 50bps on the 0% 10 year yield target.

The Fund decreased by 1.3%.

No investments called during the month.

The GRY available to investors increased once more. The terminal value of the current investments stands at 33.7% in the event markets annualise at 0% in price terms over the next three years. GRYs remain highly attractive even in equity markets that fall significantly.

The Fund decreased by 6.5% over the year, against a decrease in global equities of 17.7%. The Fund’s sensitivity to its underlying equity exposures remains within target before the protection overlay is taken into account.

As the dust settles on 2022, it will go down as perhaps the year in which irreparable damage was done to the 60/40 investment philosophy as a stand alone, all weather strategy for all times. And, more importantly, that asset allocations consisting purely of bonds and equities are not suitable across risk profiles. That is certainly not to say that the 60/40 portfolio will not have its day again, it will. The question is when. But, given correlations, and what has been seen this year as the result of markets beginning to be weaned from the performance enhancing drugs they have enjoyed for so long, there can be no argument over its fitness in isolation.

Given the price action seen in the first part of the New Year, it would seem the narrative has shifted to one of the Fed having manufactured a soft landing perfectly. Of course this is possible, but less likely than the options either side that they have either done too much already, leading to a hard landing, or not enough and, as the central banks themselves remain keen to point out, more is needed to tame the stickier aspects of inflation, namely wages. In either of the latter scenarios, equity is likely to struggle to annualise above meagre returns for the foreseeable future, and investors need to seek ways to achieve meaningful returns from other sources.