The echoes from Silicon Valley
There has been a high level of uncertainty in the markets in much of Q1 2023, with widely diverging opinions about the path the economy would take. In such an environment, any news or shock tends to have a stronger impact.
With that, the VIX index, which is also known as Wall Street’s fear gauge, shot up sharply just this past week that ended 10 Mar 2023. A large part of it was due to a series of events leading up to the failure of Silicon Valley Bank (SVB), the largest US bank failure since the 2008 financial crisis.
It all began on 8 March when SVB announced that it needed to raise US$2.25 billion to bolster its balance sheet. Its share price declined by 60% after the news. This led the tech startup and venture-capital community SVB had been nurturing and supporting to withdraw their deposits, sparking a bank run. Bank clients, mostly tech companies, worried that they wouldn’t be able to access their cash, withdrew a total of US$42 billion in deposits. The Federal Deposit Insurance Corporation (FDIC) announced on Friday, 10 March, that SVB had failed.
The markets, worried about a contagion, sold off on other banks, leading the S&P 500 to decline about 4.8% (in USD terms) in a week. At the time this article was written, SVB had been taken over by the FDIC and was seeking buyers for its assets. Many are also concerned about the fallout spreading to other parts of the world as startups and early-stage companies from London to Singapore struggle to move their deposits out of SVB.
Read more: The impact of Silicon Valley Bank's collapse on your investments
As of 12 March, it appears that the markets are pricing another 25 basis point (bps) increase in interest rates by the US Federal Reserve, rather than a 50 bps hike, given that the embattled US tech sector might not be able to withstand more hits.
Inflation, rates — a disconnect
As it is, over the last few months, there has been a strange disconnect in the markets, centering around inflation and interest rate expectations: Many investors remained positive about a “soft landing” even as central banks and economists continued to warn about sustained inflation and further rate hikes.
The release of economic data in February pointing to the strength and resilience of the US economy was a disappointment to many investors. The US jobs report in January indicated a more resilient labour market than expected. Retail sales were also up in January, about 3% on a month-on-month basis. In usual circumstances, one would expect such strong economic data to be good news to the markets — so why this strange disconnect?
After the Fed raised interest rates by 25 bps at the start of February, accompanied by a more dovish tone, market sentiment remained positive and investors were hopeful that the rate hikes may be coming to an end. However, the strong economic data and news led the markets to infer that the fight against inflation was far from over, with January inflation data coming in higher than expected (0.5% increase) and solidifying this narrative. As markets digested the prospect of more sustained rate hikes beyond the first quarter of 2023, returns of both equities and fixed income fell across the board.
Similarly, in Europe, February saw the European Central Bank (ECB) and the Bank of England (BoE) announce the raising of rates by 50 bps. While both banks acknowledged the decline in headline inflation numbers, the ECB also expressed concerns over core inflation levels and indicated another 50 bps rate hike in March.
Kazuo Ueda was appointed as the next governor of the Bank of Japan (BoJ) amid rising inflation in Japan. The consumer price index (CPI) in Japan stood at 4.3%, which was the highest seen in the past 40 years. The BoJ and the Japanese government had urged companies in the country to increase wages.
Meanwhile, China continued on its economic economic recovery path after its reopening at the end of 2022. However, rising geopolitical tensions between the US and China, especially after the spy-balloon episode, continue to cast a shadow on China’s recovery. The markets are also expecting China to continue with its loose monetary-policy stance.
February market commentary
After a strong January 2023, both the equity and fixed income markets faltered in February. The MSCI All Country World Index (net div, USD) fell 2.9% while the Bloomberg Global Aggregate Index (USD, hedged) retracted 1.6%.
In equities, emerging markets underperformed developed markets, with Colombia being one of the weakest performers for the month. Colombia has been undergoing much needed reforms to address high inflation and external fiscal imbalances. China also gave back most of its gains from January as the MSCI China Index (net div, USD) declined more than 10%. Rising geopolitical tensions between US and China, along with profit taking, drove some of the underperformance. The US dollar strengthening in February also exacerbated some of the market shocks. Europe was one of the strongest performing regions, although it did not escape unscathed from the February turmoils. Global growth stocks continue to outperform value stocks, bringing growth’s year-to-date edge over value to more than 5%.
In fixed income, yields rose across the board and corporates generally underperformed. High-yield bonds, in particular, US high yield, outperformed global investment-grade bonds. In the US, 10-year yields rose from 3.51% to 3.92%, while the 2-year yields rose from 4.21% to 4.82%, indicating a further inversion of the US yield curve.
Key performance highlights for Endowus portfolios in February
- The Flagship Portfolios underperformed the global equity and fixed income markets because of their value bias and overweight to emerging markets (EM). While the EM exposure was helpful in January, that reversed in February, with the EM region underperforming the global markets as risk-off sentiment grew.
- The equity environmental, social, and governance (ESG) portfolio generally performed in line with the global equity markets. The fixed income ESG portfolio underperformed due to its overweight in the EM and credit sector.
- All three Income Portfolios delivered negative returns for the month as a by-product of the rising yield environment, but continued to deliver their payout targets.
- All three Cash Smart solutions also had a difficult month in February, but Cash Smart Secure was able to continue generating positive returns. The Enhanced and Ultra solutions had negative returns because of their exposure to the credit sector and longer-duration bonds.
Endowus Flagship Portfolio
The Flagship 100% Equity Portfolio underperformed the global equity market by a slight margin
- Even though the tilt to value detracted from relative performance versus the broader market, the Flagship 100% Equity Portfolio benefited from a tilt to another factor: small caps. As in January, small caps continued to outperform large caps in most of the markets. This helped mitigate some of the negative impact from the value emphasis.
- The underperformance was mostly driven by the portfolio’s overweight in emerging markets versus the MSCI All Country World Index (ACWI), as emerging markets lagged developed markets by more than 3%.
The Flagship 100% Fixed Income Portfolio also underperformed the global fixed income market
- Most of the underlying bond funds in the Flagship 100% Fixed Income Portfolio underperformed the Bloomberg Global Aggregate Index — an exception was the PIMCO GIS Income Fund. Both the Amundi Index Global Agg 500m Fund and the PIMCO GIS Global Bond Fund performed roughly in line with the index.
- The worst performer for February was the PIMCO GIS Emerging Markets Bond Fund, due to an underweight to emerging market (EM) spreads and an overweight to Egypt. The fund’s security selection within Chinese corporate debt also detracted.
- The Dimensional Global Core Fixed Income Fund also underperformed the Bloomberg Global Aggregate Index, largely driven by its overweight allocation to corporate debt relative to the index.
Endowus ESG Portfolio
The ESG 100% Equity Portfolio performed in line with the MSCI All Country World Index
- The portfolio’s overweight allocation to industrials, as well as its underweight in real estate and energy sectors, helped with relative performance. Stock selection in the consumer discretionary and healthcare sectors also contributed meaningfully to relative performance.
- In terms of underlying fund performance, the biggest contributor was the Schroder ISF Global Climate Change Fund. The fund returned 0.16% for the month of February, outperforming the global equity market.
The ESG 100% Fixed Income Portfolio slightly underperformed the Bloomberg Global Aggregate Index
- The portfolio’s overweight allocation to corporate credit and emerging markets drove much of its underperformance. However, this was partially offset by the portfolio’s relatively shorter-duration positioning, and its allocation to the high-yield sector.
Endowus Income Portfolios
The Stable Income Portfolio delivered negative return in February
- The portfolio’s allocation to the US bond markets, in particular investment-grade bonds and Treasuries, detracted from performance.
- Its allocation to emerging-market bonds and Asian bonds also detracted. However, the portfolio’s overall shorter-duration positioning helped to cushion some of the downside as bond yields increased and bond prices fell during the month of February.
The Higher Income Portfolio delivered negative return in February
- The Higher Income Portfolio’s fixed-income allocation had similar performance drivers to the Stable Income Portfolio in February. However, Higher Income’s allocation to the high-yield sector helped with its relative performance.
- The Higher Income Portfolio’s equity allocation also detracted, with the allocations to real assets and emerging markets being the primary detractors from relative performance. However, fund selection in emerging-market equities provided a positive boost, as the JP Morgan Emerging Markets Dividend Fund outperformed the MSCI Emerging Markets Index in February.
The Future Income Portfolio delivered negative return in February
- The Future Income Portfolio’s allocation to the US fixed-income markets also detracted from performance, as with Stable Income and Higher Income.
- Its allocations to Asian and emerging-market equities had a negative impact on the performance of the Future Income Portfolio’s equity sleeve. This was partly offset by its allocation to European equities, one of the top-performing equity regions during the month.
All three Income Portfolios are achieving their payout targets
- All three portfolios achieved their payout targets in February.
- We recently increased the payout target ranges for the three Income Portfolios. Their latest payout target ranges, per annum (p.a.), are: 5% to 6% for Stable Income, 5.5% to 6.5% for Higher Income, and 3.5% to 4.5% for Future Income.
- The chart below shows that the annualised payout yields for the portfolios have been rising, and the latest figures fall within the new guidance ranges^.
- The increase in yields is a function of relatively stable monthly payouts and lower net asset values. This suggests higher forward-looking income if investors enter the market at this price point.
^Note: There is quarterly fluctuation in payout and yield, due to one fund paying on a quarterly basis.
Endowus Cash Smart Portfolios
Cash Smart Secure continues to deliver positive returns
- Cash Smart Secure returned 0.16% in February 2023. The Fullerton SGD Cash Fund continued to deliver consistent returns as it benefited from the exposure to higher-rate securities in the past months.
- The LionGlobal Enhanced Liquidity Fund saw a few days of small losses — its exposure to US rates had entailed higher hedging costs. The manager is currently investing maturing proceeds into SGD securities to reduce hedging costs.
Cash Smart Enhanced’s performance was almost flat during the month
- The Cash Smart Enhanced Portfolio’s performance remained flat at -0.04% for February.
- The United SGD Fund took a slight hit as its exposure to the Singapore credit sector hurt during the month, as credit fell across Asia.
Cash Smart Ultra’s performance dipped after three months of positive returns
- Cash Smart Ultra returned -0.12% in February 2023, after posting positive returns for three months.
- Its allocations to longer-dated funds such as the Nikko AM Shenton Income Fund and the PIMCO GIS Low Duration Income Fund had a negative impact on performance, as those funds (as with other longer-duration funds) were more affected by the rise in yields and the corresponding decline in bond prices.
Cash Smart projected yields have risen again as yields increased in February
- As yields rose across the fixed-income spectrum, the underlying funds of the Cash Smart portfolios were able to reinvest maturing proceeds into higher-yielding securities — locking in a higher yield range for February.
- The fall in bond prices has a negative mark-to-market impact, but this translates into a higher yield-to-maturity of the bonds that are in the portfolios.
- The rising rate environment provides an opportunity for 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 for the next few months.
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