Endowus Portfolios Performance Update (February 2024) — Land of the Rising Sun

Will prices in Japan surge to drive policy changes?

Japan is among the few markets where inflation hasn’t been a headache for households and central bankers. But instead, policymakers in Japan welcome inflation. This month, the country is concluding the spring wage negotiations, or Shunto that takes place every year. 

What’s special about this round of Shunto is that the outcome of wage increases will likely trigger a virtuous cycle of rising wages and inflationary prices, ultimately ushering an end to a decades-long deflationary economy. The country’s largest federation of trade unions says the workers are poised to receive a weighted average of 5.28% in salary increments in fiscal year 2024.

These developments will encourage the Bank of Japan (BoJ) to start normalising its policy by first reversing the yield curve-control policy and negative interest rates. Japan’s Nikkei 225 index notched a robust gain of 8% in February and its brethren, the TOPIX 100 went up 6.2%.

The 8% gain by the Nikkei 225 aside, there has been a general buzz going on over Japan the past year. What has gotten the markets so excited about an oft-forgotten country when it comes to investment allocation?

The sun is rising (again) in Japan

The Japanese equity market has experienced multiple phases over the past 20 years, characterised by periods of significant growth, stagnation, and recovery. If we had to break its journey into segments:

2004-2012: Recovery and challenges‍

After its asset price bubble burst in the early 1990s, Japan faced a prolonged period of economic stagnation known as the “Lost Decade.” Recovery attempts were made, but the 2008 financial crisis and the 2011 earthquake and tsunami posed severe challenges to regaining growth.

2012-2020: Abenomics and market growth‍

Late 2012, Prime Minister Shinzo Abe introduced "Abenomics” to revive the economy through monetary easing, fiscal stimulus, and structural reforms, which marked a turning point.

2020-2022: COVID-19 pandemic‍

The onset of the COVID-19 pandemic introduced volatility and uncertainty into global markets, including Japan. Sharp declines at the start of the pandemic were followed by modest recovery, supported by government stimulus measures and the BoJ’s continued monetary easing. 

2023-Year to Date: Recent developments‍

From tourism to export, Japan has been a major beneficiary of the post pandemic recovery era, propelling the index to a record high. A weak Japanese yen and accommodative monetary policy were a few of the fundamental drivers, with more favourable factors at play. 

In particular, corporate governance reforms in Japan, aimed at improving profitability and efficiency among Japanese companies, are making Japanese equities more attractive to both domestic and international investors. The Tokyo Stock Exchange has been exerting pressure on all listed companies to implement specific measures aimed at enhancing corporate value. This is expected to bring higher shareholder returns.  

The government's focus on digital transformation and green energy as part of its growth strategy has invigorated investor interest in related sectors in the country.

Rising inflation has also prompted savers in Japan to seek higher returns in the stock market as traditional savings options become less attractive with the anticipated end of low interest rates.

The past, the present and the future

In the past more than 10 years, the Japanese market had trailed its developed market peers by a significant margin. From 2010 to 2022, the TOPIX 100 Index (in Japanese Yen) underperformed the S&P 500 (in US dollar) by about 170% and the MSCI World (In local currencies) by about 42% in cumulative terms. However, by March of this year, the TOPIX 100 had caught up to the MSCI World and even outstripped it by 3%.

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In the period from January 2023 to the start of March 2024 (14 months), the TOPIX 100’s cumulative return was 54.4%, beating the S&P 500 by 18.3% and the MSCI World by 22%.

As of 15 March 2024, the markets are speculating that the BoJ will raise interest rates after Japan’s largest union group announced stronger-than-expected wage increases. On the back of this announcement, several asset managers have come out with favourable outlooks for both Japan equity and the yen.

Over the past 20 years, the Japanese equity market has navigated through periods of challenge and growth, significantly influenced by domestic policies and global economic trends. As always, it's important for investors to remain aware of the potential for volatility and shifts in market dynamics, emphasising the importance of a diversified and informed investment strategy. 

For investors considering Japan as part of their portfolio, Endowus Fund Smart features four Japanese equity funds (as of 18 March 2024), which allow investors to capture drivers from a broad market portfolio to a small- and mid-cap strategy and invest in factors from quality to growth. 

Elsewhere, inflation needs to fall further 

Over to the other side of the world, broad-market indexes are also hitting all-time high. 

In the US, inflation remains the primary concern before the Federal Reserve can confirm its victory in curbing escalating costs. Most recently, the US market appeared to be somewhat complacent following a speech by Jerome Powell, the Chair of the US Federal Reserve, with the S&P 500 index hovering at a historical peak.

Powell had confirmed that the Fed was "not far" from gaining the confidence it needed, in the falling inflation figures, to begin cutting interest rates. Still, a March interest rate cut is unlikely, with 90% of fund managers we surveyed responding that the first rate cut may come later in the year, as inflation is still above the Fed’s long-term inflation target of 2%. 

Despite the recent peak in interest rates, the high cost of borrowing has not deterred the continued run in the S&P 500 index, with Magnificent 7 stocks leading the benchmark to new heights. In February, the index advanced by another 5%. With the primaries underway, the US is steps closer to determining its next leader. With ​​Joe Biden and Donald Trump clinching nominations from their respective parties, the stage seems set for a repeat of the 2020 election showdown.

February market commentary

After a slow January, the markets roared back to life in February. China enjoyed a significant rebound with the CSI 300 returning more than 9% (in CNY). Japan was a distant second with TOPIX 100 coming in at 6.2% (in JPY). The S&P 500 returned a respectable 5.3%. India’s return in February was disappointing with the Nifty 50 at 1.3%, underperforming the rest of the major Asian markets.

February data in the US continued to paint a picture of economic resilience. CPI dropped from 3.4% in January to 3.1% in January but ticked up again to 3.2% in February.

In terms of factors, small caps generally underperformed large caps across the board. Although in the US, the small cap stocks did hold up well against large caps. The difference in performance was negligible. Growth was, once again, the flavour of the month as growth stocks outpaced value stocks in the US, developed markets and emerging markets.

Turning to fixed income, we saw yields increase as investors anticipated that central bank rate cuts may come later rather than sooner.  Credit did well - high yield bonds outperformed investment grade bonds. EM debt (hard currency) also did well.
In February, the S&P GSCI Index experienced a slight uptick, driven by increases in livestock and energy prices which balanced out declines in agriculture, industrial metals, and precious metals sectors. Within the energy category, crude oil and Brent crude rose while natural gas experienced a significant decline. Agriculture was the index's weakest segment during the month.

Key performance highlights for the Endowus Portfolios in February

• The Flagship 100% Equity Portfolio performed in line with the broader global equity markets in February. The portfolio’s structural overweight to value detracted but the negative impact was mitigated by the overweight in emerging markets, which outperformed developed markets this month.
• The fixed income sleeves of the Income Portfolios outperformed the benchmark, benefitting from the shorter duration positioning and strong fund selection. The portfolio's equity segment generated positive returns, but its tilt towards the value factor caused it to underperform the broad market, which has been driven by growth stocksin February. 
• All three Cash Smart solutions continued to generate positive returns in February.

Endowus Core-Flagship Cash/SRS Portfolio

The 100% Equity Portfolio performed in line with the broader global equity markets in February

• The global equity markets — represented by the MSCI All Country World Index (ACWI) — returned almost 5% in February, boosted by strong performance from China and the US. The Equity Portfolio’s structural overweight to value detracted but the negative impact was mitigated by the overweight in EM as EM outperformed DM.

The 100% Fixed Income Portfolio beat the broader global fixed income markets by 0.3% during the month

• The global fixed income markets — as represented by the Bloomberg Global Aggregate Index — posted negative returns as yields increased and bond prices fell, once again. 
• The PIMCO funds contributed to relative performance as they outpaced the Bloomberg Global Aggregate Index in various degrees. The PIMCO Emerging Markets Bond fund was the strongest performer in the line-up with its focus on the EM debt segment.

Endowus Core-Flagship CPF Portfolio

‍The 100% Equity Portfolio outstripped its benchmark by 0.4% in the month of February

• The Portfolio’s structural overweight to EM proved beneficial in February as EM outperformed DM. The best performing funds in the equity line-up were the Amundi Prime USA and the Schroder Global Emerging Opportunities funds.

The 100% Fixed Income Portfolio beat its benchmark by a slight margin in February

• The global fixed income markets — as represented by the Bloomberg Global Aggregate Index — posted negative returns as yields increased and bond prices fell, once again. 
• The only fixed income fund that posted positive returns during the month was the United SDG Fund. Its shorter duration positioning with respect to the benchmark helped as longer duration bonds, with their higher sensitivity to interest rate movements, declined more. The Eastspring Singapore Select Bond also contributed to relative performance as it beat outperformed the Bloomberg Global Aggregate Index.

Endowus Income Portfolios

The Stable Income Portfolio demonstrated robust performance in February, outperforming its benchmark by 0.6 percentage points.

• The portfolio's shorter duration, compared to the benchmark, played a pivotal role in its relative performance. The stronger-than-expected January US inflation figures led to a recalibration of investor expectations regarding Federal Reserve interest rate cuts for 2024, favourably impacting the portfolio’s positioning.
• The fund selection yielded positive results, with all underlying funds surpassing the benchmark. Additionally, the portfolio’s allocation to emerging markets contributed to the portfolio's outperformance. 

The Higher Income Portfolio outperformed slightly the 20-80 benchmark in February

• The portfolio's fixed income segment did well, benefiting from its shorter duration stance, fund selection, and strategic allocations to emerging markets and the high-yield sector.
• The portfolio's equity segment has a tilt towards the value factor, causing it to trail the broader equity market as the growth factor outperformed value once again. Moreover, the allocation to real assets detracted from the relative performance, as the anticipation of slower interest rate cuts overshadowed the positive effects of supportive activity data.

The Future Income Portfolio performed in line with the 40-60 benchmark in February

• The portfolio's fixed income component outperformed due to its shorter duration positioning and strong fund selection.
• However, the equity component faced slight underperformance against the equity market.

All three Income Portfolios are achieving their payout targets 

• Actual payouts have remained stable despite the fluctuation of prices across the three portfolios. Volatility in price returns will result in mark-to-market changes (decrease or increase) in the portfolio value, but will not impact the actual coupon payments or dividend payouts from the underlying funds. 
• Yields in the fixed income market have risen meaningfully following the increase in global interest rates, creating a higher yield environment for income-seeking investors. 

Endowus Cash Smart Portfolios

Cash Smart Secure continued to generate stable and positive returns

• Cash Smart Secure generated 0.3% in monthly returns for February 2024.
• Over the past year, we've seen a stable pattern in month-to-month returns, suggesting that yields may have reached their peak. 

Cash Smart Enhanced experienced steady growth

• Cash Smart Enhanced returned about 0.2% in February 2024, maintaining its positive return profile this year
• There was a slight pullback in February compared to January returns, from the slight volatility stemming from the Chinese market during the period. 

Cash Smart Ultra achieved positive returns in February

• All underlying funds delivered positive returns during the month.
• Returns were somewhat subdued compared to January, influenced by the release of the US inflation data and volatility in the Chinese market.

Cash Smart projected yields have started to recede from peak yields

• As the markets started to price in the possibility of peaking interest rates and potential rate cuts, money market and short duration bond funds saw a slight decrease in yields.
• The rising rate environment in the past two years has provided an opportunity for the managers of the underlying funds to reinvest and allocate the coupon payments and cash from maturing bonds to higher-yielding bonds.

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