The 3rd quarter of 2022 kicked off with a sense of optimism as global markets started discounting the potential easing of monetary policy in 2023 by the Federal Reserve. This optimism was quickly doused at the Jackson Hole summit in August when the Fed made it clear that their priority is price stability and not economic activity. This stark stance against inflation was also echoed by other central banks around the world.
The Fed in particular faces a difficult trade-off. Inflationary pressures are moderating in the US on the back of lower oil and food prices. The labour shortage is still a big driver behind the elevated inflation statistics. The solution is painful – crush demand with higher rates to force supply cuts which ultimately leads to a softer labour market. Markets are now pricing in a much more aggressive path of future rate hikes, with rates now expected to rise to 4.5%, 3.5% and 5.75% by next year in the US, Europe, and the UK respectively.
This new paradigm shift of higher rates for longer has resulted in the repricing of all asset classes. Since the beginning of the 2022, investors have had no place to hide. In fact, if markets stay the course, 2022, will only be the 5th year since 1928 during which equities and bonds face bear markets simultaneously.
The MSCI All Country World Index, a broad measure of global equity markets, fell 5.83% during the third quarter. The Sasfin Multi Asset Class Strategies (MAS) currently have exposure to the S&P 500 index and the Europe, Australasia, and Far East Index (EAFE) index. The EAFE index is designed to give investors exposure to the most developed countries of the world outside of North America.
During the third quarter, the S&P500 index and EAFE index returned -6.27% and -4.04% respectively. Global equity market valuations have now generally fallen below their 25-year averages. Even in the US, the market is currently trading on a price-to-earnings (P/E) ratio of 15.6x vs. a longterm average of 16.6x. However, these valuations are based on current consensus analyst forecasts for earnings growth, which are gradually being revised down. Therefore, we could still potentially see further declines in equities.
The global fixed income market felt the full brunt of the steep rise in interest rates. The US 10-year Treasury yield jumped more than 30% during the 3rd quarter. Fixed income investors have witnessed a sharp decline in their capital due to the inverse correlation between the price of bonds and the yield of bonds.
The MAS portfolios exposure to inflation linked bonds (TIPS) has outperformed on a relative basis, with a total return of -2.91% during the quarter. This sub asset class has served us well in this period of decade-high inflation.
The more aggressive high-yield short duration corporate debt exposure on the portfolios has also performed well on a relative basis, as expected, with a total return of -0.63% for the quarter. We kept the exposure to these bonds when we optimised our portfolios in April. In our opinion investors will be forced to accept the risk of BB-rated and B-rated corporate debt to earn a real return. This basket of corporate bonds held within portfolios has a weighted average maturity of 3.2 years and an average yield to maturity of 9.30%.
The current risk-off sentiment does not bode well for our hard-currency emerging market government debt. This sub asset class had a total return of -7.13%. We expect this asset class to remain under pressure, but the basket of emerging market debt we hold, has a very attractive average yield to maturity of 8.44%.
Listed private equity companies were not spared in this time of volatility. This asset class is also sensitive to the higher cost of capital and elements of their investment portfolios might have to be repriced to adjust for potential lower returns.
Despite this, we’ve have had positive updates from some of our private equity holdings during the quarter. Blackstone achieved $88 billion of inflows in the quarter amidst all of the market chaos. This was their second highest quarterly inflow ever and ironically, equivalent to their total assets under management (“AUM”) at the time of their IPO in 2007. Over the past 12 months, inflows reached $340 billion, driving a 38% increase in AUM. Blackstone now have AUM of $941 billion. KKR ‘s management fees were up 39% in the last quarter. Since 2019, KKR assets under management, management fees & and capital invested have all been growing at a compounded annual growth rate of approximately 30%.
Despite the market sell off and volatility, our holdings continue to grow and get stronger, and operate with secular tailwinds as more money flows into private equity.
Our MAS portfolios have limited exposure to Real Estate and the exposure we do have provides investors with access to many of the attractive secular themes we invest in namely 5G, Big Data and Cloud Computing.
Our Real Estate exposure is through an ETF (Exchange Traded Fund), essentially a portfolio of companies that derive at least 85% of their earnings from Data Centres, Communication Tower Companies, and/or the infrastructure related to these sub-sectors of the property sector, often referred to as Specialised Real Estate.
This ETF’s total return in the 3rd quarter was -18.09%.
The S&P Goldman Sachs Commodity Index (S&P GSCI) which serves as a benchmark for commodities investments achieved a positive return in the 2nd quarter. Energy was the best performing component and Industrial metals was the worst performing component. During the quarter the price of aluminium, nickel, zinc, and copper declined significantly.
Within the agriculture sector, the prices for wheat, corn and cotton were all lower and in the precious metals sector, the price of silver declined sharply. The decline in the price of gold was less pronounced.
Our MAS portfolios’ commodity exposure is through an investment in Blackrock’s Resource and Commodity Strategy Fund and an investment in a physical gold ETF. The Blackrock fund had a total return of -1.76% during the second quarter. The Gold ETF declined by 7.46%.
Our bullish secular view on infrastructure remains intact. This real asset class will benefit as we build a carbon-neutral world and develop mega cities to cater for the continued urbanisation of the population. The energy crisis faced by Europe because of the Russian invasion of the Ukraine will also fast-track the development of alternative energy sources in this region.
The equity market selloff did not spare this asset class. During the quarter we witnessed declines in the Global Infrastructure ETF and the Global Water Infrastructure ETF of -8.24% and -5.90% respectively.
The infrastructure companies we hold in our portfolios also came under pressure with Brookfield, Williams Companies, Engie and United Utilities declining with -7%, -7.29%, -0.27% and 19.02% respectively.
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