Portfolio Manager Update

To the latest Market Commentary

Ethna-DEFENSIV

Key points at a glance

• Interest rate cuts in 2024: Almost all central banks except Japan cut rates several times, supported by falling inflation, while recession fears remained in the eurozone.
• Market reactions: In Europe, bond yields fell as expected, while in the US yields rose despite interest rate cuts, driven by the robust economy and fiscal uncertainties.
• Ethna-DEFENSIV: With a performance of 5.25%, the fund benefited from coupon safety, tighter spreads and a tactical duration overlay.
• Outlook 2025: Fewer US rate cuts expected; opportunities for US Treasuries on falling inflation.
• Volatility: Trump’s re-election increases uncertainty; the fund remains flexible to benefit from trends and surprises.

31 December 2024 – In retrospect, 2024 will be remembered for the start of the cycle of interest rate cuts in almost every developed country. With the exception of Japan, all major central banks have cut their key interest rates several times during the year. The Swiss National Bank led the way, followed by the Swedish Riksbank, the Canadian and European central banks, and most recently, the US Federal reserve. These measures have been made possible mainly by a significant fall in global inflation rates. In the US, CPI inflation was reduced from a maximum of 9.1% to 2.7% and in Europe from a maximum of 10.6% to 2.2% by the end of 2024. In addition, concerns about the economic strength of all developed countries resurfaced during the year. While these concerns eased in the US in early autumn, mainly due to a series of robust labour market reports, a possible recession in the eurozone remained a constant factor for interest rate cuts by the ECB.

The second key feature of last year was the reaction of the markets to the interest rate cuts. While yields on European government bonds fell more or less in line with policy rates, the market reaction in the US was very unusual. Despite 100 basis points of interest rate cuts in the US since September, 10-year Treasury yields have risen by around 90 basis points. Historically, this is a very unusual reaction, as the long end of the yield curve tends to fall parallel to the fed funds rate. This unusual development can be explained by the fact that the US economy is in a very robust state even without additional stimulus from interest rate cuts. In addition, market participants were concerned whether such additional support from the Fed would lead to a resurgence of inflation. The chaotic statements by the newly elected President Trump certainly partly also played an important role, in which most investors saw inflationary tendencies. In the corporate bond markets, we saw very strong demand throughout the year, as well as rising issuance volumes in the primary markets. The large and well-known companies with solid business models and established market positions, in which we have been invested almost exclusively for some time now, are currently benefiting from generally solid balance sheets and an overall healthy fundamental situation. As a result, risk premiums on corporate bonds both in the US and Europe have fallen significantly, in some cases to record lows.

Against this backdrop, the Ethna-DEFENSIV has achieved a very good annual performance of 5.25%. This performance was achieved based on three main pillars of our portfolio management approach. Firstly, we benefited from a constant positive coupon contribution last year thanks to our focus on higher coupon safety, which we aimed to implement by 2023. Secondly, we benefited from much narrower spreads of the corporate bonds in our portfolio. The total performance contribution from corporate bonds in our portfolio was 4.79%. The third pillar of our portfolio management is the tactical use of the duration overlay, which contributed a solid 1.8% to performance over the year.

Looking ahead to 2025, we expect a conducive environment for bond markets. We do not currently share the market consensus on the inflation outlook and the number of upcoming US rate cuts. Instead, we currently expect more than two US rate cuts between now and the end of 2025. However, the consensus view is that the Fed will slow its monetary easing due to the robust and stubborn or resurgent inflation. Our baseline scenario remains a further slowdown in US inflation, which should push down yields on longer-dated US Treasury bonds. Based on this expectation and a significant increase in inflation expectations priced in by the market, there is an attractive contrarian case for going long on US Treasuries.

Another no less important expectation for 2025 is the return of volatility. With the re-election of US President Trump, uncertainty about future US policy has only increased, which will automatically lead to greater uncertainty among market participants. It is precisely for this reason that we look to 2025 with confidence. The Ethna-DEFENSIV has a long track record of flexible and active portfolio management, which we will be pursuing this year. The high degree of flexibility should enable us to benefit from both expected and unforeseen developments.

Ethna-AKTIV

Key points at a glance

• The Ethna-AKTIV (T) lost 1.83% in December.
• We continue to expect interest rates to fall. The modified duration of the bonds was increased from 5.2 to 5.6 and further to 10.3 via US interest rate derivatives.
• The net exposure of the equity portfolio was increased from 40.8% to 42.7%. On the one hand, the core portfolio, which is invested exclusively in US large caps, was expanded to 35.6%. On the other hand, equity futures were reduced from 8.2% to 7.1%.
• The portfolio has a foreign currency exposure of 0.7%. The hedge implemented in October remains in place.
• Given the moderate growth environment, we also expect price gains in line with expected earnings growth (8-12%) in 2025.

31 December 2024 – In 2024, the positive stock market trend of the previous year continued with the tailwind of rising earnings and the absence of external shocks. The Ethna-AKTIV successfully participated in this trend with an annual performance of 6.03%. However, the performance over the past two years was by no means uniform: While the fund generated around two-thirds of its annual profits in the last six weeks of 2023, the ytd-profits of 2024 were cut by around one-third in the last four weeks of this year.

At the beginning of 2024, we were faced with an exciting contrast: the scepticism of entrepreneurs (Main Street) on the one hand, and the optimism of stock market players (Wall Street) on the other. We saw a positive sign in this contradiction – and our assessment turned out to be correct. As time went on, the high level of planning uncertainty among corporate executives subsided and investors were justified in their positive outlook.

Elections in more than 70 countries have been a major source of uncertainty. In the US, Donald Trump's second term will begin in 2025. Even before he takes office, there has been a serious divergence in economic performance between the US and the rest of the world. Positive economic and stock market developments in the US were expected to favour the re-election of incumbent Joe Biden. However, inflation, which was perceived as too high during his tenure, has become his political stumbling block. Interestingly, however, the decline in inflation was sufficiently advanced for central banks to cut interest rates. As in previous years, the huge volatility in expected rate hikes provided good opportunities to profit from exaggerated expectations. In particular, our duration overlay proved to be an effective tool. Over the course of the year, the number of Fed rate cuts priced in until the end of 2025 fluctuated by four to five steps on three occasions. This also affected the long end of the US yield curve. The positive contribution of the bond portfolio to the annual performance of 2.88% was increased by a further 136 basis points through the interest rate overlay.

Global equity indices continued their upward trend from 2023. Driven by the major tech stocks, the US indices once again topped the winners’ list in 2024. This once again confirms that our 100% US exposure in the equity portfolio proved to be the right strategy. At the same time, we are critical of the increasing concentration of indices and performance drivers. Nevertheless, we have made only minor adjustments to our allocation so far: we neutralised our overweight in technology stocks in favour of pharmaceutical and healthcare stocks. With an equity allocation increased to an average of 29% over the year, the equity portfolio, including the overlay, contributed 5.36% to the annual performance in 2024. This means that both the bond and equity portfolios achieved the 4-6% performance corridors targeted at the beginning of the year.

This year has also been marked by moments of stress. In early August, the unwinding of yen carry trades led to significant disruptions in stock markets around the world. At that time, our fundamentally positive economic outlook had not changed: we stayed the course and even took advantage of the situation. Even positive stress events, such as the almost 40% rally in Chinese equities in just six days in September, have not caused us to deviate from our strategy. While we generally welcome the Chinese government’s support for the Chinese economy, we believe that the measures taken so far are insufficient. We expect further measures to follow in response to President Trump’s initial policy moves. In our view, the current mix of sharply falling interest rates, fiscal austerity and lack of stimulus is dangerous.

Looking ahead to 2025, we continue to expect a heterogeneous development across economic regions. We see the US economy as having an advantage over the eurozone, given Trump's policies and the Federal Reserve's supportive stance. Unless external shocks materialise, global real economic growth of 2.5% to 3% remains our main scenario. However, given the elevated valuation levels, we do not expect a further increase in valuations (higher P/Es), but rather earnings growth in line with economic growth. Under these conditions, high single-digit to low double-digit gains in equity indices appear to be most likely. We therefore start 2025 with a relatively high net equity allocation of 42.7%.

Although we do not consider Trump’s policy to be overly inflationary, inflation is likely to remain a dominant theme in 2025. Given the high debt levels and the risk of an economic slowdown, a certain inflation level is likely to be accepted and not fought excessively with higher policy rates. Of course, no central banker can admit this. But 3-4% inflation is easier to digest than low growth or rising unemployment. In our view, the bond market, which is still responding to the current policy of rate cuts with rising interest rates at the long end of the yield curve, will come to recognise that a second inflation wave, akin to the 1970s, is unlikely. We therefore expect lower interest rates in 2025 and will maintain our elevated interest rate sensitivity. The modified duration of the bond portfolio of 5.6 will be increased to 10.3 through the overlay. Assuming stable economy, we expect the interest rate differential between Europe and the US to narrow. Contrary to market consensus, we expect the US dollar to enter a period of weakness. All currency exposures will therefore remain hedged at the beginning of the year.

Although bond spreads have widened slightly in recent weeks, they are still very narrow by historical standards. In the absence of external shocks or a recession with corresponding defaults, these narrow spreads can persist for a very long time. Our baseline scenario assumes no change to the current situation. For this reason, we are maintaining our bond portfolio and avoiding high-yield investments, as per our strategy for the Ethna-AKTIV. The average rating of the bonds in the portfolio is A to A+ and the current yield stands at 4.5%.

One thing is certain: 2025 will be characterised by the targeted utilisation of opportunities and a stable strategic direction. With a clear focus on quality, we are well positioned to navigate flexibly – for sustainable value creation and a successful portfolio for the long term.

Ethna-DYNAMISCH

Key points at a glance

• 2024 was a generally positive year for equities, and the Ethna-DYNAMISCH successfully took advantage of this.
• Beneath the surface, performance was again very mixed, with a wide dispersion ranging from German small caps to European blue chips to US mega-cap tech stocks.
• Expectations for 2025 are high, but largely justified.

31 December 2024 – We like to build on our previous statements and put new insights into context. That is why our 2024 review begins by revisiting what we said a year ago:

“Our overriding considerations for 2024 revolve around the moderation and normalisation of many relevant parameters. Inflation moderately above central bank targets, the incipient normalisation of interest rates, and muted but sufficient growth form the core scenario, which coincides with fair to slightly undervalued equity markets. It might be hard to construct ex-ante giant leaps at index level based on this outlook, but it is a highly attractive starting point that cannot be underestimated – especially since the valuations of many equities apart from the Magnificent Seven hold additional opportunities, and others besides these seven still offer an interesting growth profile.”

In broad terms, this was indeed the narrative thread that ran through 2024, providing a tailwind for global equity markets by large. There were, however, several nuances that warrant separate mention. The services sector has been the main driver of global economic growth.  Although there were repeated attempts of improvement in the manufacturing sector, these never really gained momentum. This pattern was evident across all regions. Among the major economies, the US was the best performer in this divided environment, while Germany’s industry-heavy economy stagnated. Meanwhile, inflation continued to fall, although not as steadily as many central banks and market participants had hoped. Nevertheless, most central banks initiated interest cut cycles over the course of the year. The European Central Bank announced its first rate cut in June, followed by the US Federal Reserve in September. Both have so far cut rates by 100 basis points. Further rate cuts are expected in 2025. Despite these rate cuts at the short end of the yield curve, bond yields at the long end rose during the year. Ten-year US Treasury yields ended the year at 4.57% (vs. 3.88% at the end of 2023), while their German counterparts yielded 2.37% (vs. 2.02 at the end of 2023).

As anticipated in the outlook cited earlier, equity markets have largely coped well with the environment described above. However, even here, developments were by no means uniform. In Europe in particular, the upward trend stalled as early as mid-May and yielded no further gains in the second half of the year (for context: the pan-European STOXX Europe 600 gained 6.0% over the year). German small and mid-caps, as represented by the MDAX and SDAX, were even among the few segments to post negative performance over the year. In the US, stock markets were once again characterised by the ups and downs of the so-called Magnificent Seven - namely the major US technology companies Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia and Tesla, whose absolute and relative weighting in 2024 has increased significantly. One could fill pages just describing the performance of these seven stocks over the past year without it ever getting boring. The performance of this “group”, whose market capitalisation of 17 trillion euro exceeds that of the entire European stock market, has also become increasingly heterogenous. At this point, however, we will confine ourselves to summarising the US equity market by noting that the S&P 500 rose by 23.3% (capital-weighted) or 10.9% (equal-weighted) in 2024, depending on the approach taken. Various small and mid-cap indices were also in the range of the performance of the equal-weighted index.

For Ethna-DYNAMISCH, we have been able to take advantage of the generally constructive equity market environment by maintaining a strategically high equity allocation of around 75%. In the meantime, we have reacted to temporary clouds on the horizon with tactical hedging, reducing the net equity allocation three times to around 50% throughout 2024. As a counterpart to the equity portfolio, for a long time we focused only on short-term bonds with high credit ratings and cash. Both had attractive interest rates and were not exposed to any significant interest rate risk. It was only when bond yields rose sharply in the fourth quarter of 2024 that we started to build up positions in long-dated US Treasuries again at the end of October, which accounted for 5.1% of the fund’s portfolio at the end of 2024.

Beneath the surface, equity markets offered a little more room for active management, where there were certainly larger swings over the course of the year. Market participants’ general assessment of the economy, the interest rate environment and the opportunities in individual sectors varied considerably during the year. We took advantage of these rotation movements and continuously adjusted the position sizes of the individual stocks held in the fund (mostly a reallocation from outperformers to temporary laggards). However, completely new stocks were also regularly added to the fund following price weaknesses and were often given a high weighting immediately. However, there were also stocks whose short- to medium-term price potential we no longer considered attractive enough to continue holding within the fund after strong price rises. This counter-cyclical approach has allowed us to keep the fund’s risk/return profile broadly staple despite the continued price gains. A significant part of the gains in the equity indices in the second half of the year was due to a widening of valuations. By comparison, the equity portfolio in the Ethna-DYNAMISCH ended the year at a considerably lower valuation, with an expected price/earnings ratio of 13.4. This is not only 31% below the MSCI World Index at the same valuation metric, but also more than half a point below the fund's own valuation figure as of 30 June 2024.

Looking ahead to 2025, our concentrated equity portfolio of currently 33 single stocks gives us additional confidence in achieving an attractive performance. We also draw general confidence from our macroeconomic baseline scenario, which continues to foresee adequate economic growth. This assumption is based on healthy labour markets, which should continue to drive consumption, but also on further interest rate cuts and a realistic chance that the manufacturing sector will finally regain momentum after two years of prolonged crisis. Added to that are the prospects of deregulation, tax cuts and an increase in corporate takeovers. At the same time, there are geopolitical and inflationary risks, which we believe are manageable for the time being.

Ultimately, the biggest potential hurdle could be the fact that 2025 already starts with high expectations. Often the greatest pleasure lies in the anticipation of the good things that are yet to come. And in 2024, the market has already priced in a lot of anticipation. Be it artificial intelligence, the impact of Trump, interest rate cuts or economic growth.

With its diversified approach and selective stock-picking, the fund is well positioned to take advantage of opportunities while effectively managing risks. In particular, the high degree of flexibility should enable us to benefit from both expected trends and unforeseen developments in 2025.

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