Portfolio Manager Update
Ethna-DEFENSIV
Key points at a glance
- Yields still rising despite interest rate cuts
- Our focus is on euro investments and short residual maturities
- Bonds an attractive asset class once again
30 June 2024 - The rising trend in ten-year sovereign bond yields that began in 2022 continued in the first half of 2024. This seems counterintuitive, as it was during this time that many central banks began cutting interest rates, but not so much when we recall the situation at the beginning of the year. Back then the markets had priced in around six interest rate cuts both by the Federal Reserve and the ECB. Much fewer are expected now and the Federal Reserve hasn’t even begun lowering interest rates.
While the ECB and the Fed were in no rush to cut key rates, the Swiss SNB pressed ahead and made its first cut in March, bringing interest rates down to 1.5%. Its second followed in June. This was somewhat unexpected but is not surprising given inflation rates in Switzerland and the SNB predicting average inflation of 1.4% in 2024, 1.2% in 2025 and 1.1% in 2026.
The Ethna-DEFENSIV’s bond positioning was cautious throughout the first half of this year. By focusing on euro investments and short residual maturities, interest income was optimised and exchange rate fluctuations were reduced. This was our reaction to yield curves for German and U.S. sovereign bonds, which remain inverted, with the highest yields at the short end of the yield curve. In addition to the bond investments, the Portfolio Management team also actively implemented futures strategies, in particular on long-dated bonds. For example, we initially bet successfully on rising yields, as the expectations for rapid and hefty interest rate cuts by the central banks were excessive. Of late we have again used strategies that benefit from falling U.S. sovereign bond yields. We expect the U.S. central bank to soon commence interest rate cuts as well.
The much higher yields in the past two years have made bonds an attractive asset class once again. As a result, in April 2024 the Ethna-DEFENSIV paid out more than the minimum distribution (1.5%) for the first time in a long time. For 2023, approx. 2.32% was paid out in the A class. The interest income received in the first half of the year and the average coupons in the current bond portfolio mean it is very likely that the next distribution will be higher again.
Turning to the second half of the year, inflation expectations and the unemployment figures will remain the key determining factors in interest rate policy and how bond prices develop. The Ethna-DEFENSIV Portfolio Management team will actively manage the portfolio in the second half of the year and react to any changes in expectations so as to continue the positive performance seen in the first half of the year.
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
- After a successful first six months, the year-to-date performance of the Ethna-AKTIV (T) stands at an all-time high of 4.35%.
- Portfolio remains geared towards an environment of moderate growth, falling but stubborn inflation and a rising stock market trend.
- The equity component stands at 25.8% due to the lack of market breadth and is exclusively invested in U.S. large caps.
- We continue to shift the high-quality bond portfolio into longer maturities. The portfolio modified duration of 3.5 was raised to 5.8 via the duration overlay.
- Portfolio exposure to the U.S. dollar is 27.1%.
30 June 2024 - The purpose of this monthly commentary is to broaden the perspective. After summarising the first six calendar months, we will look ahead to the rest of the year.
June was a microcosm of what we have observed throughout the year to date. All asset classes in which we invest contributed to the performance of the Ethna-AKTIV. After the best performance for the month this year (1.91%), the fund stood at a new all-time high at month-end. There are a variety of reasons for this development.
One of them is the long-awaited turnaround in interest rates. The Swiss National Bank kicked off rate cuts in March; the ECB was next in June and the Fed is expected to follow suit in September. However, the torrent of interest rate cuts priced in at the beginning of the year failed to materialise – as we expected. Inflation has not yet returned to pre-pandemic levels but seems sufficiently under control on the face of it. We have our doubts about this and only expect a few interest rate cuts; that is, of course, provided an economic upturn, delicate flower that it is, actually materialises. If it doesn’t, heftier interest rate cuts could be needed, which doesn’t match our baseline scenario. Within the portfolio, this was taken into account as follows. At the beginning of the year, prompted by the fanciful notions of interest rate cuts we had fully hedged the interest rate risk in the expectation that interest rates would in fact rise. Over the course of the year, this hedging was not only reversed but, as interest rates rose, interest rate sensitivity was increased both by extending bond duration and by means of the overlay. Both tactics were successful.
Another reason is the wave of AI exuberance that broke last year. As the saying goes, a rising tide lifts all boats. The tide in this case is the high-cap technology companies associated with AI, who have benefited more than most. The difference in performance between the equal-weighted and capitalisation-weighted S&P 500 shows how divided the equity market is on this front. While the equal-weighted index gained approx. 5% in 2024, the capitalisation-weighted index gained an impressive 15%. This lack of market breadth makes it all the more important to avoid selection pitfalls. As in 2023, we succeeded in doing so. Our focus on U.S. securities again paid off. One reason for investing exclusively in U.S. securities is that whenever political risks arise in Europe, even good European securities get damned by association. The fact that a general election was called in France after the results of the European elections proves this point. While the U.S. indices were up by a comfortable margin in June, Eurostoxx et al. fell.
This was the exact context in which the third major portfolio component of the Ethna-AKTIV worked. After both the interest rate and growth differential obviously were not really reflected in a stronger U.S. dollar, it was the political uncertainty surrounding this election that weakened the euro. This resulted in the U.S. dollar position making a positive contribution to performance.
Looking ahead we are sticking with our theory of moderate growth at global level. Considering that, based on current fiscal packages, the U.S. budget alone is running a deficit of approx. USD 2 trillion, we can safely rule out a recession any time soon. In the short term, everything is being done to appease the consumer (= voter), to ease the price pressure and, whatever happens, to maintain the value of people’s share portfolios. How sustainable this policy is in the long term, now that’s quite a different matter. As a result, despite the fact that valuations are high in historical terms, we can expect a tolerable investment environment. However, until there is an improvement in equity market breadth, we are keeping the equity allocation around 25%. On the interest rate front, we are firmly of the opinion that interest rates have peaked. For this reason, we continue to lock in the quite attractive yields by extending duration further. Rounding out and balancing the portfolio is a U.S. dollar allocation of 27.1%.
We are aware that the going will not be smooth. For the second half of the year, investors can continue to rely on our active and flexible approach, which, when necessary, will entail adjusting the portfolio with a view to long-term capital growth.
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
- The first half of the year saw mainly rising equity markets.
- Performances became much more divergent towards the midway point, recalling the first nine months of 2023 in terms of structure.
- We remain confident about the second half of the year and expect the gap that has recently opened up in valuations to close.
30 June 2024 - Good communication should be a constant. It should regularly tie in with previous statements and place new information in the context previously communicated. With this in mind, we would like to begin this mid-year review of the first six months with our outlook on 2024, which we published at the turn of the year. We wrote in the Market Commentary at the end of December:
“At the core of our broader considerations for 2024 is the moderation and normalisation of many key framework conditions. ... Inflation is only moderately above central bank targets, the interest rate environment is normalising and growth remains subdued but satisfactory, coupled with fair to slightly undervalued equity markets. This approach may not enable significant immediate advancements at the index level, but it offers a promising starting point. Beyond the renowned Magnificent Seven, there exists a wealth of untapped potential within the valuations of numerous stocks, all of which continue to exhibit an intriguing growth profile.”
Broadly speaking, this was indeed the narrative that ran through the first half of the year and it lent a further tailwind to global equity markets. Looking at it in more detail, however, the tailwind was more a series of gusts than a steady breeze. While the economy has been heading in the right general direction, it hasn’t been able to gather momentum. Inflation fell further, albeit not as consistently as many central banks and market participants had hoped. Nonetheless, the European Central Bank (ECB) made its first cut in key rates in June, and further cuts are expected before the end of the year. In the U.S., the Fed is more hesitant and has not yet brought itself to cut interest rates for fear of a resurgence in inflation, as has often happened in the past. The delay in expected interest rate cuts put a stop to the fall in bond yields observed in Q4 2023. U.S. and German sovereign bonds are again trading much higher than at the start of the year, creating a headwind for equity prices.
Our Market Balance Sheet analysis is an effective tool that enables us to keep an eye on opportunities and risks in the markets. Throughout the first half of the year the positive and negative factors were very much in balance, though the economic momentum and the not unattractive starting valuation tipped the scales in the direction of the positive. On the whole, this led to a rising trend in equity markets, with the underlying structure strongly recalling the first nine months of 2023. Once again it was mainly a few U.S. technology stocks with very large market capitalisation that drove the major equity indices such as the MSCI World and S&P 500, massively skewing them upwards compared with the performance of all other equities. But even the price of the “median share” in the above indices still climbed 4.4% (i.e. one half of the index did better, the other half worse). Only smaller-cap names have in many cases barely budged in 2024 as well. The negative six-month performance of -7.2% for Germany’s MDAX was the most prominent example of this.
Within the Ethna-DYNAMISCH, we acted on the generally constructive outlook by running a strategically consistently high equity allocation of around 75%. At the same time, we reacted to passing clouds with tactical hedges, bringing the net equity allocation down to around 50% at times. These measures not only helped to reduce the interim volatility but also produced a positive contribution of 0.54% to performance in the first half of the year. In counterpoint to the equity portfolio, meanwhile, we only used short-dated bonds with high ratings as well as cash. Both have again offered an attractive rate of return of late and have no interest-rate risks. This contributed 0.46% to performance in total. Foreign currencies, largely resulting from global equity exposures, made a slightly positive contribution of 0.28%, primarily on the back of a U.S. dollar that has been stronger since the beginning of the year, whereas many other currencies fell against the USD and the EUR.
Within the equity portfolio, all 33 constituents (as at the end of June) were trading in a range typical for equities, without any major positive or negative outliers. Broadly speaking, the fundamental performance in particular was satisfactory, which underpinned and confirmed our optimistic attitude. Still it must be said that equity market volatility has of late been increasing rather than decreasing below the surface. We saw opportunities to be had and increased portfolio activities accordingly to keep adjusting position size (where price gains were excessive, funds were shifted to laggards) but also to add brand new stocks, such as Volkswagen and Reckitt Benckiser, to the fund following falls in prices, and to weight them prominently. In the second quarter in particular it was almost exclusively the (big) U.S. technology stocks that provided any impetus to speak of, while the wider market and the portfolio stagnated at best. So it’s no wonder that there has been lots of talk among investors of late about the Magnificent Seven and, in particular, about frontrunner NVIDIA. This is understandable considering its six-month performance of around 150%, as every percentage point weighting of NVIDIA would translate into a 1.5 percentage point contribution to equity portfolio performance. Of the Magnificent Seven, the Ethna-DYNAMISCH portfolio contained and contains Alphabet (Google), Amazon and Microsoft. While we might have considered opening a position in NVIDIA at the start of the year, the share moved out of our price range in a very short space of time.
This would imply that some of the outlook on the second half of the year has already been anticipated. The very fact that even a non-NVIDIA investor can hardly avoid bringing up and voicing an opinion on the world’s largest chip developer is itself worth mentioning. Somewhat less tied in with individual names is the fundamental attractiveness of the equity market, which, as mentioned at the beginning of the year and quoted above, we believe is intact. That said, the divergent price performance of late has had an effect on the valuation and thus also on our assessment of the risk-reward ratio of individual segments of the market. While plenty of speculation has already been priced in, particularly in the semiconductor sector, investors seem to be lacking in imagination to a certain extent when it comes to the broad market despite the very robust fundamentals. We think both are unwarranted and would not be surprised if the aforementioned “median share” continues to forge ahead while the flights of fancy of individual technology stocks undergo a correction. As always, past performance is not indicative of current or future performance; share prices may rise or fall. But a high degree of flexibility, as with the Ethna-DYNAMISCH, allows for rapid adaptation to changing circumstances over time.
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
France on the brink
- Politics moved European markets in June, stocks and bonds started to price in an unfriendly outcome in France snap parliamentary election.
- Global yields drifted lower as the US economy showed some signs of softening momentum and the ECB followed other central banks cutting rates for first time.
- In the Eurozone, spreads widened as Macron’s decision to call for snap elections sent shockwaves through markets.
- Yen slid to weakest since 1986, raising the risk of currency interventions. Political uncertainty in Europe and the Fed’s higher for longer mantra bolstered the dollar in June.
- US stocks set new highs as tech dominance drove indices with poor market breadth.
- Asian stocks were mixed. Investors remain unconvinced by Chinese property policies while Korean and Indian stock markets soared.
- The HESPER FUND – Global Solutions posted a solid 1.38% gain in June.
- The HESPER FUND – Global Solutions refined its portfolio allocation. Net equity exposure was reduced to 30% dumping European indices and the overall short duration stance was first sliced to an almost neutral of -0.1 and then raised by the end of the month to -0.9. In FX market, the fund kept its long exposure to the Norwegian krone of 20%, increased its US dollar exposure to around 36%, cut its GBP short exposure to -23% and traded CHF to end the month with a short exposure of -9%
30.06.24 - Volatility ignites markets as elections and political campaigns keep rolling
Political uncertainty made investors more and more sensitive to political and regulatory risk both in emerging or developed countries. Political developments in Argentina, Taiwan, South Africa, India, Mexico and the EU have jittered financial markets so far this year. Now is the turn of France and the UK, and in November we will witness the big rematch between Biden and Trump.
Markets sometimes overreact to political risk. Very soon, we will observe markets reaction to the French elections. Agitated investors already bashed the stock market and drove up bond yield premia at the widest in 12 years since Macron’s decision to call snap legislative elections. In the UK, investors are complacent. Despite a likely large Labour majority, a conservative meltdown and the rise of populist far-right Reform party, the behaviour of the British pound and the gilt markets have been muted so far. In the US, Biden’s disastrous first debate sparked Democratic concerns over his candidacy.
The Fed will very likely cut rates but it will still lag behind its peers
As widely expected, the ECB cut rates in June following other central banks but the Fed skipped again the decision waiting for further evidence that inflation is sustainably on its way to the 2% target. The Swiss National Bank surprised the market with a second consecutive rate cut.
The disinflationary path is still ongoing in most countries, albeit at a much slower and more uncertain pace than in 2023. Bumps on the road to disinflation are appearing, as was recently the case for Canada and Australia where inflation accelerated in May. The Fed’s preferred inflation gauge rose in May at slowest pace since March 2021, bolstering the case for lower interest rates later this year. The Fed will very likely cut rates this year but the easing cycle will be short and shallow, and rates are likely to remain higher than in previous cycles as natural rates are suspected to be much higher. Thus, the direction of travel seems clear but the path for rates remains rather uncertain.
The Fed’s “higher for longer” policy bolstered the dollar in June. In turn, bond investors continued to downshift their expectations for a meaningful rate-cutting cycle as the soft landing scenario is gradually looking more likely. Politics in Europe increased volatility and dampened investor sentiments as Marine Le Pen’s far-right party gained more traction.
Nvidia’s wild stock swings put AI rally’s stamina on spotlight
Thanks to the tech dominance, US main equity indices hit record highs despite lower expectations for the Fed pivot. Poor market breadth was a constant again. US stocks were supported by fears of missing out. Despite wild swings from its very high peak right after becoming the world most valuable company, Nvidia ended up the month on strength, posting a 12% monthly performance on top of its already outrageous stellar 10-wager return since the beginning of last year. In June, the S&P 500 soared 3.5% and the DJIA rose by 1.1%. The tech-heavy NASDAQ jumped 6% thanks to the stellar performance of Nvidia, which continues to ignite AI hopes. The small cap index Russel 2000 fell 1.1% as high for longer rates blocked its take-off.
In Europe, the Euro Stoxx Index fell 1.8% (-3% in USD) dragged down by French stocks. The CAC 40 plunged 7% and the FTSE 100 slipped 1.4% (-2% in USD) as political risk grew heavy. The Swiss Market Index stalled, edging down 0.1% (+0.5% in USD).
In Asia, stocks were mixed. On the one hand, Chines shares ended lower. The Hang Seng Index decreased by 2% while the CSI 300 Index decreased by 3.3% (-3.6% in USD). The Korean stock market rebounded 6.1% (+6.5% in USD) and the Indian Sensex surged 6.9% (+7.3% in USD as the rupee strengthened once the market shrugged off the election results. The Japanese Nikkei rose 2.8 (+0.6% in USD) despite higher yields and fears of currency intervention due to the weak yen.
HESPER FUND – Macro Scenario: slow disinflation means cautious and slow pivots.
The easing cycle has started but is still missing the main actor, i.e. the US Federal Reserve. Central banks are navigating a challenging scenario characterised by uncertain disinflation, tepid economic activity amid political elections, and rising geopolitical tensions. Policy is at an inflection point: timely and gradual easing will foster a soft landing and prevent unnecessary economic pain. Central banks are however wondering about the level of policy rate that will bring inflation sustainably towards the 2% target.
As long as the economy remains stable, the job market healthy and prospects of future rate cuts in sight, the outlook for stocks is positive and rotation should improve the market breadth.
The challenge of stubborn inflation within a soft-landing scenario is likely to be a source of concern for the bonds market, while offering support to risk assets such as equities and commodities. It seems unlikely that a meaningful rate-cutting cycle will be implemented. Policy easing is coming, but the cuts will be slow and not as deep as expected given the strength of the economy.
Politics has begun to bother the markets as the French political turmoil spread to the wider Eurozone market. For countries such as France and Italy that have been already reprimanded for its deficit by the EU, concerns about fiscal profligacy are rising.
Positioning and monthly performance
The HESPER FUND – Global Solutions (T-6 EUR) gained 1.38% in June, supported by equities and FX. YTD, the fund is up 4.39%.
In order to balance the portfolio in this challenging environment of a soft landing, slow and bumpy disinflation trend and political uncertainty, the HESPER FUND built up a short position in Italian and French sovereign bonds and continued to keep its equity exposure mainly in the US. Duration exposure was kept slightly negative (-0.9 years) with a long position in short-dated bonds to profit from the inverted yield curve, and a short position in longer dated bonds of Italy and France and to lesser extend the US Treasury. The fund continued to trade actively in the FX space, keeping dollar exposure at 36%. GBP short exposure was also kept at -23%. The NOK long was maintained at 20%. The fund successfully traded the CHF several times to end up the month with a short exposure of 9% against the USD.
The breakdown of June performance (+1.38%) was +0.35% fixed income (+0.34% long positions, +0.01% short futures positions), +0.89% equities, -0.07% commodities, +0.33% currencies and -0.11% fees and expenses. Decorrelation with traditional assets such as equities and bonds remained high.
Total assets rose to EUR 57.5 million at the end of the month. The T-6 EUR unit class remained below its all-time high on 29 September 2022 by 6.4%.
Volatility over the past 250 days remained stable at 6.1%, maintaining an attractive risk/return profile. The annualised return since inception has risen to 3.54%.
Looking ahead to next month, the fund has continued to stay far away from its reference currency and to trade actively in the FX space. Currently, the currency exposure of the HESPER FUND – Global Solutions is as follows: USD 36%, NOK 20%, CHF -9% and GBP -23%. We start the month with small short positions on Italian BTPs and French OATs futures.
As in the past, we will continue to monitor and calibrate the fund’s exposure to the various and different asset classes in line with market sentiment and changes in the macroeconomic baseline scenario.
*HESPER FUND - Global Solutions is currently only authorised for distribution in Germany, Luxembourg, Belgium, 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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