In the beginning
When Endowus conducted a market outlook survey with top asset management companies at the beginning of this year, we saw a few common sentiments among the companies. China’s growth was likely to be the highest among all the major countries and would stay high for the next two years.
In terms of market expectations and investment opportunities in equities, emerging markets and China ranked the highest by far, with Europe and US at the bottom.
We are almost at the end of the third quarter — so let’s review how markets and economies around the world have played out against expectations.
At the start of 2023, there was quite a bit of pessimism with regards to the US economy and, in particular, the aggressive pace of rate hikes that the Fed had undertaken to combat persistent inflation.
There were more than a few economists and market experts who forecast that the US will enter into a recession in the later half of this year. While there is still time for the economy to turn, the likelihood of a recession has gone down. Banks and other major financial institutions have downgraded the chances of a recession occurring this year, forecasting instead a higher chance of the US achieving a “soft landing”.
The Endowus 2023 market outlook survey results indicated a 2% gross domestic product (GDP) growth rate for the US in 2023. The July 2023 World Economic Outlook Update report shows the US economy growing around 1.8% in 2023. This is about in line with the estimates. However, Bloomberg reported last week that the Fed may double its GDP growth estimates amid strong data on consumer spending and residential investments.
In fact, one unofficial estimate has the US expanding a whopping 5.6% on an annualised basis in the third quarter. While this Atlanta Fed tracker is unofficial and volatile, it nonetheless highlights a marked change from previous sentiments.
The caveat here is that despite the resilience in the economic data and the economy, most economists still expect a significant slowdown in US growth in the fourth quarter of 2023 and into 2024.
August was marked by negative headlines about China’s property sector as Country Garden, China’s biggest home builder, was thrust into the limelight after it missed interest payment on its bonds. Fortunately, Country Garden was able to receive an extension on its payments and avert a default. A few days later, Evergrande, another troubled property developer, filed for bankruptcy in the US.
The Endowus 2023 market outlook survey showed optimism in China, as estimates for the country’s 2023 GDP growth ranged between around 3% and 5%.
While there have been recent downgrades on forecasts of China’s growth, the July 2023 World Economic Outlook Update report still indicates a 5.2% growth rate in 2023. This is on the higher end of the estimates seen in the Endowus market outlook survey and higher than most other countries.
However, economists have downgraded Q3 2023 growth from 4.6% to 4.4%, and the Q1 2024 estimated growth rate is now 4.2% versus 4.3% from the previous survey.
How the markets have done
The faith and optimism placed on China and the emerging markets as growth investment opportunities have not really played out as of now. In US dollar (USD) terms, China trailed the other markets by a wide margin, almost detracting by 5% as of 31 Aug 2023.
The two best major markets for the year on a USD basis have been Europe and the US, for different reasons, while the best major market on a local currency basis has been Japan.
The main lesson from this is that it is really difficult to predict how markets will perform in the future, even for very knowledgeable market experts. We give the best estimates we can at the time, with the most information we can find but circumstances change and the world does not stay static from that point on.
Without knowing which markets will outperform, the best option would have been to go with a globally diversified portfolio, as depicted in the chart above.
While an investor would not have performed better than if he had invested solely in the US, he would still have done much better than if he had invested all his assets in the other regions or been overweight in China and emerging markets (which was the recommendation of many experts).
August market commentary
Global equity markets fell in August 2023, reversing the gains from July and ending close to where they were at the end of June. The picture was similar for emerging markets, albeit with larger volatility. The only major market to record modest gains was Japan as measured by the TOPIX.
In the US, several of the large technology names softened. The US economy has remained impressively resilient, but longer-term worries still linger despite the increased probability of a “soft landing”.
In Europe, persistently high headline inflation and the larger interdependencies with China — whose outlook dimmed substantially in recent months — were the main drivers of weaker stock markets.
While the Chinese government took some modest steps to stimulate consumption in July, the consensus is currently rather bleak, and the property market in particular contributed to the decline in August.
In terms of factors, global small-cap stocks underperformed large caps, and value slightly underperformed growth. More generally, quality names as measured by profitability and balance sheet strength, remained stable.
The recent big news in global bond markets was the downgrade of US government debt to AA+ by Fitch Ratings. 10-year government bond yields rose briefly to new highs, but then retreated. The Fed continues to monitor inflation and has not ruled out further rate hikes.
Concerns about Europe, especially Germany and the UK, drove negative returns and widened credit spreads.
China has become an outlier compared to the rest of the world, with worries about deflation instead of inflation, and the property market being cyclical instead of defensive.
Key performance highlights for the Endowus Portfolios in August
- The Flagship 100% Equity Portfolio underperformed the global equity market due to its structural biases in small caps, value, and emerging markets. The Flagship 100% Fixed Income Portfolio was flat against the benchmark.
- The ESG (Environmental, Social, and Governance) Portfolios lagged both the global equity and fixed income markets due to challenges from its lack of exposure to the energy sector, as well as security selection in industries such as financials and renewable energy on the equity front, and overweight allocations to emerging-market debt and credit on the fixed income side.
- All three Income Portfolios lagged their benchmarks by a modest margin, facing headwinds on both the equity and fixed income components. However, all three portfolios continue to achieve their payout targets.
- All three Cash Smart solutions continued to generate positive returns in August as well.
Endowus Flagship Portfolio
The Flagship 100% Equity Portfolio underperformed the global equity market in August by a slight margin
- The global equity markets — represented by the MSCI All Country World Index (ACWI) — retracted by a small margin in August (in SGD terms). Emerging markets (EM), once again, faced headwinds and underperformed developed markets, and small-cap stocks were outpaced by their large-cap peers. Value stocks showed slight underperformance against growth stocks in the US but performed marginally better outside of the US.
- The Flagship 100% Equity Portfolio faced headwinds from its tilts towards small-cap stocks and a slight overweight in emerging markets.
The Flagship 100% Fixed Income Portfolio performed in line with the global fixed income market in August
- The global fixed income markets — as represented by the Bloomberg Global Aggregate Index — had a slightly negative month, similar to the Endowus Flagship 100% Fixed Income Portfolio.
- Most of the underlying fixed income funds in the portfolio performed in line with the broad benchmark. The portfolio’s allocation to EM bonds via the PIMCO GIS Emerging Markets Bond Fund detracted slightly from relative performance, but the negative impact was mitigated by the portfolio’s allocation to the Dimensional Global Core Fixed Income Fund, which did slightly better than the rest.
Endowus ESG Portfolio
The ESG 100% Equity Portfolio lagged the broader equity market in August by 1 percentage point
- Similar to July, the fact that the ESG 100% Equity Portfolio had no allocation to the energy sector hurt its performance in August, as the energy sector was the best-performing equity sector for the month.
- The portfolio’s selected positions in the financial sector and the renewable energy segment also dragged on its relative performance, though the negative impact was somewhat mitigated by its security selection in the healthcare sector.
The ESG 100% Fixed Income Portfolio underperformed the broad fixed income market in August by 0.3 percentage point
- The ESG 100% Fixed Income Portfolio is overweight on EM bonds and credit risk. This allocation detracted from its relative performance in August, as there was weakness in EM debt and credit spreads widened during the month.
- The portfolio’s shorter-duration positioning partially offset the negative relative performance.
Endowus Income Portfolios
The Stable Income Portfolio underperformed the broad fixed income market in August by 0.6 percentage point, after its outperformance in July
- The portfolio’s allocation to EM bonds and Asian bonds contributed negatively as both markets experienced declines.
- That said, the portfolio’s shorter-duration positioning had a positive impact, partially offsetting the underperformance from the EM and Asian allocations.
The Higher Income Portfolio underperformed the 20-80 benchmark in August by 0.7 percentage point, after it had outperformed in July
- On the fixed income front, the portfolio’s allocation to Asian bonds was the largest detractor. However, its shorter duration and its allocation to high yield helped cushion some of the downside, as the high-yield sector was one of the best-performing fixed income sectors in August.
- On the equity front, the portfolio’s allocation to EM equities and listed real assets detracted as both underperformed MSCI All Country World Index (ACWI). The portfolio’s currency hedging also hurt its relative performance, as the US dollar appreciated further in August, bolstering the unhedged equity performance.
The Future Income Portfolio underperformed the 40-60 benchmark in August by 1.2 percentage points, after it had outperformed in July
- On the fixed income front, the portfolio’s allocation to Asian bonds and EM bonds detracted, while its shorter duration and its allocation to high yield helped.
- On the equity front, the portfolio’s allocation to Asian and EM equities, as well as its currency hedging, had a negative impact on relative performance.
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.
- As the chart below shows, the annualised payout yields for the portfolios have been rising as a function of stable monthly payouts and lower net asset values from late 2021 to around October 2022. Since then, yields have remained elevated compared to historical levels.
- 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
- The Secure portfolio delivered positive returns in August 2023.
- Its underlying funds, the Fullerton SGD Cash Fund and the LionGlobal SGD Enhanced Liquidity Fund, continued to do well through their ultra-short duration positioning.
Cash Smart Enhanced achieved moderately positive returns in August
- The Enhanced portfolio continued its positive performance in August, following a moderately positive month in July.
- Both the underlying funds in Cash Smart Enhanced managed to generate positive returns despite market volatility in the Asian fixed income sector, as these funds invest in high-quality securities.
Cash Smart Ultra ended August on a relatively muted note
- The Ultra portfolio saw modest returns in August, primarily influenced by volatility in the Chinese fixed income market, which affected the Shenton Income Fund.
- The portfolio's other underlying funds contributed to relative performance amid market volatility, offsetting the negative impact from the portfolio’s allocation to the Shenton Income fund.
- Regardless, the Ultra portfolio remains the top-performing Cash Smart solution year-to-date, proving its potential for high returns, albeit with a higher level of volatility.
Cash Smart projected yields have been on an upward trend with rising interest rates
- The fall in bond prices has a negative mark-to-market impact, but this results in a higher yield-to-maturity of the bonds that make up the portfolios.
- The rising rate environment provides 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. The managers of the underlying funds will continue to take advantage of this environment as they reposition their funds over the next few months.
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