After the sharply lower global markets of the second quarter of 2022, the third quarter began with some optimism that inflation would soon peak and that in the near-term central banks and the US Federal Reserve Bank in particular, would bring an end to aggressive monetary policy tightening. The narrative at the time was around a “Fed pivot” where the Federal Reserve would soon stop the rapid hiking of interest rates and even begin contemplating a first rate cut in the earlier part of 2023. By mid-August, in the middle of the quarter, the Sasfin Innovation Portfolio’s benchmark, the Russell Small Cap Completeness Growth index, was up 21% for the quarter. Global markets were buoyant, and the broader mega-capitalisation S&P 500 index was up by almost 14% at the same time. It was towards the end of August that the Federal Reserve Bank poured cold water on the market’s enthusiasm with a much tougher stance on its monetary policy response to persistently high inflation.
The rhetoric from the Federal Reserve turned to a “higher for longer” view on interest rates as the US central bank aggressively targeted inflation expectations. The defining moment for that policy stance came at the Jackson Hole monetary policy symposium in late-August and was followed by the same hawkish tone whenever a Fed official found themselves in front of an audience. The September US Federal Open Market Committee (“FOMC”) meeting sealed the deal on another weak quarter when the Fed raised rates by 75 basis points for a third consecutive time and issued an updated “dot plot”, the quarterly view of FOMC members’ interest rate expectations for the coming years and for the longer term. The dot plot portrayed a view of interest rates potentially being hiked by more than was being expected and for longer than was being expected. Markets gave up their more recent gains and the S&P 500 ended the quarter down by just over 5%, the NASDAQ Composite closed 4% lower and the Russell Small Cap Completeness Growth index, the portfolio’s benchmark, finished the quarter at an almost identical level to where it ended the previous quarter (+0.2% q/q).
A number of the Sasfin Innovation Portfolio laggards in the second quarter were the big winners in the third quarter. The Trade Desk, a digital advertising platform and marketplace, returned just over 42% for the three-month period. Cloud networking solutions company Arista Networks was up 20% and global satellite communications company Iridium Communications was up 18%. The best performing exchange traded fund (“ETF”) in the portfolio for the quarter was the ARK Genomic Revolution ETF with a price gain of 4.3%.
Amongst the laggards over the quarter, 3D printing business Stratasys finished 23% lower while technology-related real estate investment trust Digital Realty was down 24% for the three months. Wireless communications company Interdigital declined by 33% over the quarter.
The worst performing ETF for the period was the Global X Video Games and E-sports ETF with a price decline of just under 15%. The gaming industry has been under pressure in recent quarters with a dearth of new gaming titles being published – largely a function of tighter Chinese regulations around gaming content and the impact of higher inflation and interest rates on the disposable incomes of consumers. While the economic slowdown is expected to continue into 2023, there are a wide range of new gaming titles from key franchises slated to be published in the next two years.
In the current risk-off environment where funds have moved out of all manner of assets into the safe-haven of the US dollar, there has been a broad decline in the global equity markets. Uncertainty around future policy direction, economic growth and corporate earnings has additionally raised the level of volatility in the markets. While that uncertainty prevails and the Federal Reserve keeps to its “higher for longer” mantra on interest rates, equity markets are expected to remain volatile and under pressure. It’s never advisable in times like these to try and second guess the market’s tops and bottoms and it’s preferable to stay the course and remain invested through the cycles for the longer term.
The best defence that the management team of the Sasfin Innovation Portfolio has during times like these is to make sure that each and every investment instrument in the portfolio can justify its inclusion on an ongoing basis. New holdings are brought into the portfolio only on the back of a strong investment case and that investment case is regularly reviewed and tested with the publication of quarterly results and often additionally between results dates. The investment case of even the best company can sometimes falter and that’s why ongoing diligence (but not necessarily trading) is a prerequisite. The investment team will continue to manage the portfolio on this basis, making sure that the portfolio holdings represent the best longer-term investments into the exciting world of innovation.
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