Endowus Q4 2021 Performance Review — Will The Tiger Be Unleashed This Year?

Endowus Investment Office Q4 and EOY 2021 Commentary

Global macro concerns are rising amidst policy uncertainty in the US and China. The concern is that the Fed continues to surprise the market on the upside while China’s lack of transparency weighs heavily on markets. Uncertainty is never good for markets, but this heightened level of uncertainty is raising volatility in markets and leading to a short term market correction for all asset classes. The big question is whether this is just a healthy correction or the beginning of a downturn in the cycle. As we approach the onset of the new Year of the Tiger, the only thing that is certain is that there is nothing certain about the future. 

Before we delve into the outlook for the new year, let us first look back at historical returns. The chart below shows how the Endowus portfolios have done against the global comparable benchmark indexes in the past few years. The Flagship Endowus portfolios were designed to gain broad exposure to global markets in a strategic and passive asset allocation (as opposed to tactical - short term opportunistic - and active allocation that most of our competitors espouse) and largely track the global indexes over time. The chart clearly shows that the portfolios achieved those aims. While some variations exist, the performance for 2021 was stellar and some even beat benchmarks, which compares starkly to many other investment options including roboadvisors from digital and incumbent players that sharply underperformed. Many active management options that have shown short term outperformance also significantly underperformed the passive benchmark returns.

Q4 2021 Market Updates

Q4 2021 Global Equity Market Performance 

The global markets, especially developed markets, showed less volatility last year without a major correction throughout the year. However, the emerging markets and Asian markets, despite starting the year strong, had a tough year. The cautious response against the Delta variant and later the Omicron variant led to divergent economic activity and market responses. China’s no tolerance policy on Covid-19 as well as the crackdown on its property sector had a domino effect across equities and fixed income especially in Asia and Emerging Markets.

There seems to be a shift from growth to value and quality that is detected across markets after a decade of growth outperformance. The Asian equity market has gone from being the best performing market in 2020 to the worst performing in 2021. The quilt chart below again highlights how it is difficult to predict which market or sector will outperform in the future. The S&P 500, index after a stellar performance in 2021, is already the worst performing this year.  

While investors can have satellite positions to express their view and convictions, their long term portfolios must be anchored with a strong allocation to the Core portfolios that provides broad, global diversified exposure to markets across sectors and factors. This conviction and discretion should be made by investors, rather than have an advisor or platform dictate this for them.

Q4 2021 Global Fixed Income Market Performance‍

For the fixed income market, 2021 was overall a challenging market with most global government and credit markets suffering a loss for the full year with the only stellar performance coming from inflation-linked and high yield sectors in developed markets. This was offset by severe weakness in Asia and Emerging Market credit and high yield, especially driven by China and its significant weakness especially in 2H 2021. The quilt chart shows again the randomness of returns in the fixed income market across geography and sectors.

The persistently high inflation numbers that many had hoped would start stabilising actually continued to surprise on the upside leading to global central banks,  announcing several tightening measures such as interest rate hikes. The Federal Reserve in the US has shifted its monetary policy from a gradual to a more urgent pace of tightening including tapering of asset purchases, interest rate hikes commencing from March 2022, and a faster pace of reduction in its balance sheet. The Federal Reserve, to tackle sustained cost push inflation from tight labour market and supply-side bottleneck, is withdrawing liquidity from the money supply. 

Given this backdrop, the fixed income markets struggled throughout Q4 and into 2022. However, despite this, the overall fixed income asset class ended with a slight negative return in Q4 and 2021 full year. The biggest hit to fixed income markets came in a narrow slice of the market and mostly in China and Asia High Yield. The below chart shows how the global credit and especially Asia High Yield has underperformed the broader fixed income asset class.

This again highlights the importance of having a truly globally and sectorally diversified Core fixed income investment portfolio to diversify away the concentrated risk of taking a specific country or geographic bet. We must always start with Core portfolios before extending our exposure in a manageable way into Satellite portfolios and other idiosyncratic risk in single name securities.

Endowus Advised Portfolio - Q4 and 2021 Performance

We provide commentary and detailed breakdowns of drivers and characteristics for each of the Core Advised Portfolios from Endowus below.

Flagship Cash/SRS Core Advised Portfolios‍

Key Performance Highlights: Q4 showed a divergence of performance between equities and fixed income, with our Flagship Cash/SRS 100% Equity Portfolio bouncing back favourably and generating 5.9% return during this period. The Flagship Cash/SRS 100% Fixed Income Portfolio, on the other hand, ended Q4 with a small negative return.

The rebound in equities was driven by value and small size factors which meant that the Flagship portfolios with its factor tilts from exposure to Dimensional portfolios that invest in the proven long term factors of return, performed slightly better than the others. 

On the other hand, the global fixed income markets were buffeted by elevated inflation, the increasingly hawkish tones from the Fed and other central banks around the world, and the emergence of the Omicron variant. As a result, the shorter-dated bonds were hit more by the hawkish central bank outlooks and credit lagged government bonds for the quarter. Closer to home, the Asian and Emerging Market bonds continued to be negatively impacted by the uncertainty surrounding the Chinese property sector. All these factors contributed to the slight negative performance of the Endowus Flagship Cash/SRS 100% Equity Portfolio in 2021 Q4. 

All-in-all, the Endowus Core Flagship Cash/SRS Equities portfolio ended 2021 with strong performance, outperforming the MSCI ACWI as it especially benefited from factor rotations into value and small companies during the year. We continue to hold our conviction that factor tilts towards the long-term proven drivers of return, such as value, small cap and profitability, will drive excess returns in the long run.

On the fixed income side, our portfolios also performed well compared to major market benchmarks for the full year of 2021. It was more defensive in a generally negative and uncertain environment for the fixed income market.

Core Flagship CPF Portfolios

Key Performance Highlights: Similar to the Cash/SRS portfolios, the Endowus Flagship CPF Portfolios finished Q4 with a solid rebound in equities, with the 100% Equities Portfolio generating 5.4%. Its 100% Fixed Income Portfolio pulled back slightly delivering -0.2%.

The Flagship CPF Portfolios wrapped up 2021 well, with four of six of its portfolios outperforming the CPF-OA interest rate of 2.5%. The CPF portfolios for all investors should naturally be biased towards a higher allocation to equities for the same level of risk. Not only is the time horizon different, it is also money that is locked up and something we cannot touch anyway - and hence investors can overcome short term volatility to take on some more market risk by exposing to the equities complex more so than in other portfolios. The second reason is that the CPF fixed income complex and options are limited as there is a lack of access to good products including PIMCO and Dimensional at the moment. This is another reason we should be slightly more underweight fixed income and overweight equities for your CPF portfolio. 

The 2021 performance of the more conservative 20-80 and 100% Fixed Income portfolios were dragged down by Q1 losses (driven by inflation concerns at the beginning of the year), although the returns throughout the remaining parts of the year helped to mitigate the initial loss partially.

ESG Core Advised Portfolios

‍Key Performance Highlights: Endowus’ industry-leading Core ESG Portfolios continued to deliver stellar returns. After a strong third quarter outperforming the broad equity market by more than 2%, the Core ESG 100% Equities portfolio continued its positive performance in the fourth quarter and ended the second half of the year with strong overall outperformance. The 100% Fixed Income portfolio pulled back slightly after its great defensive performance in Q3 2021. 

Overall, the ESG portfolios ended the year strongly. Outperformance of the equity portfolio in the second half of the year partially compensated for the weaknesses in the first half of the year caused by a rally in traditional energy or commodities names, bringing the full year performance to be in line with the broader market. The fixed income portfolio managed to outperform the benchmark in this challenging environment. This testifies to how investing in companies with sustainable business practices does not necessitate sacrificing return. In fact, our Core ESG portfolios have exhibited defensiveness and delivered favourable returns.‍

Endowus portfolios outperform other robo-advisors & benchmark‍

A common question we get from our clients or at our webinars is how we stack up against competitors and other investment options, especially Robos. There are no official ways to track performances across platforms. While Endowus is the only digital and online wealth platform of any kind to transparently publish all our portfolios and their performance and construction, most others do not show the performance numbers so it is impossible to compare.

However, we have increasingly seen more bloggers and community sites publish their investment portfolios. This monthly publishing on Seedly by a member has been the most consistent one that people seem to track and therefore, we are sharing with our investors to show how we stack up against some other players in the field. Obviously, each company has a different strategy but the bottom line is that Endowus is the only one with a strategic and passive asset allocation, while the other two players obviously follow a very active and tactical asset allocation style that has obviously led to poor performance last year. We are publishing the numbers as it is and for the exact period published on Seedly and you can see the article here.

Based on these publicly-available comparisons, other robos have consistently underperformed throughout 2021. Not only has the Endowus Flagship equities portfolio massively outperformed its peers, it's important to note that Endowus is the only one that managed to beat the global index - MSCI ACWI, while the others lagged quite significantly. The chart below shows graphically how Endowus Flagship has largely tracked and outperformed ACWI and versus the others. More pertinent issue has been the significantly higher volatility and low hit rate of the other robo performances, especially when they promise an all-weather, lower volatility investment approach. 

This is in comparison with Endowus generating only 3 months of negative returns with one of those month a meagre 0.02% fall, compared to the others that had 5 or 6 months of negative returns dragging down the return numbers for the year and one even returned a negative return for the full year in a year when the market was up more than 20%. 

‍2022 Outlook - Growth is not the concern‍

As we enter the Year of the Tiger, volatility and uncertainty has risen significantly. It may be ominous that while the tiger in the Zodiac is seen to have characteristics such as being brave and confident, it also has traits such as uncertainty or unpredictability. Many uncertainties persist as 2022 begins, including whether Covid becomes endemic post-Omicron, the shape and speed of the Fed and central bank monetary policy tightening, and the outlook for growth in the economy and markets more broadly. The corrections to markets and growth sectors at the outset may feel ominous, but a correction following a sharp sustained market rally is not uncommon. 

While growth concerns do exist it is important to anchor any macro discussion with the proper context that we are coming out of a massive growth shock and that we are in the mid-cycle of a recovery with demand remaining robust. We are not in a late cycle or facing a recession. It is however becoming more apparent that inflation is persisting due to the ongoing bottlenecks on the supply side which is leading to cost-push inflation. Covid-induced global lockdowns meant that factories stopped running and workers stayed home, but now that consumers are spending again, the backlog of supply is struggling to catch up with associated costs rising and being passed on to end consumers. All major components of inflation - whether it is food, fuel, homes or labor - are all at cyclical highs and remaining higher for longer.

The Fed is gearing up to introduce a faster-than-expected pace of policy rate normalisation. This signals a moving away from the Fed’s “gradualist” approach by accelerating both the tapering of bond purchases and interest rate hikes, which are now expected to begin in March based on the Fed Committee's December minutes, along with a faster pace of rate hikes throughout this year. In a way, the recent market correction is a short term readjustment to the reality of a faster than expected increase in interest rates. We have moved from just 1 or 2 rate hikes in 2022 just a month or two ago, to now expecting a minimum 3 or 4 rate hikes this year with some predicting as many as 6 rate hikes. 

Higher rates are coming - market move to 3-4 rate hikes in 2022

Impact on equities‍

The markets are pricing in this new reality into current prices. More than anything else, rate hikes have a meaningful impact on valuations of equities. The value of stocks represents the present value of all future cash flows. With the discount rate to calculate that present value rising from higher inflation, future cash flows are worth less today. This is especially true in a situation where inflation is already high, and continues to rise further. In such scenarios, historically, equities have only managed to exceed the inflation rate in less than half of the time. Whereas in all other scenarios of Low inflation and rising, or in a scenario where inflation is falling, equities returns have a high probability of exceeding inflation rates.

Some equities sectors, however, are relatively more shielded from the impacts of inflation than other sectors – energy, mining, and REITs for example as opposed to out and out growth sectors, such as technology that are more negatively impacted, again highlighting the importance of sectoral diversification.

Impact on fixed income‍

The rate hike may be seen as a bigger cause for concern for fixed income investors as rising yields immediately lead to market losses as bond prices fall to adjust for the rise in interest rates. The duration of the bonds directly reflect this interest rate risk, however this is offset by the yield or coupon on the bonds as well as maturing bonds being repriced and reinvested at higher yields with rising interest rates. Over time, as long as credit risk is not heightened and exhibited in credit defaults, the bonds will all eventually mature and reprice to par. With the global economy mid-cycle in terms of its growth outlook, and while the supply side needs to play catchup, the demand side is not a major cause for concern.

This is why tracking default rates across the credit and high yield sector is an important barometer and especially in the US and developed markets, the fixed income market is being driven purely by the adjustment in interest rate risk and credit risk remains benign. China, and Asia by default since China represents such a large portion of the market, remain a headwind to fixed income returns and this is a segment that is struggling with credit risk. 

Aside from high yield, convertibles and floating rate bonds are also less sensitive to rate increase as convertibles have an embedded option to convert to equity under certain conditions. Floating rate bonds, such as inflation linked or bank loans, have variable interest rate structure so their coupon actually increases as interest rate increases. This again supports the importance of sectoral diversification in your fixed income portfolio across various market cycles.

Amidst all the concerns surrounding the broader macroeconomic landscape, listed companies are still overall delivering strong earnings growth. While valuations remain high for equities both cyclically and especially on a cyclically-adjusted basis. Fixed income spreads are also generally on the tight side suggesting there isn’t a lot of obvious value across the sectors, however, there does seem to be valuation attractiveness across all of Emerging Markets for both equities and fixed income. While valuations, in and of itself, is never a catalyst for relative outperformance, the Emerging Markets generally are offering better risk-adjusted return outlook barring any systemic concerns in important countries within EM, such as China. The situation in Ukraine with Russia’s involvement and potential impact of sanctions continues to weigh on Emerging markets and needs to be monitored.

‍Valuations are a headwind but earnings growth remains strong

‍Market falls intra-year rarely tells the story of the whole year‍

As we being the year, we are experiencing the first meaningful drawdown (peak to trough falls) in a while. Maybe it is time to jog our memory since we went through a whole year, especially in the US markets (represented by S&P 500 Index here) without a 5%+ correction. It is one of very few years in which this has happened. In fact, a 5% correction should happen almost every year, as looking back at history between 1928 to 2020, it occurred in 94% of the years. A 10% correction happens 63% of the time in any given year. And a 20% or worse correction happens once every four years. However, what is important to note is that in many of the years in which we see intra-year pullbacks, the markets actually ended the full calendar year in positive territory. We don’t have to look far back in history as the last 30% correction in markets occured less than 2 years ago in March 2020. The markets ended that year in positive territory. Over the long term, we know that the market rewards investors who invest for the long term and lookthrough this market drawdowns, however painful it may feel at the time that we are going through it. The numbers tell the story and time in the markets and not timing the market is what results in good outcomes for investors.

Lastly, it is important to accurately assess your investment needs and risk appetite to design a strategic asset allocation that you can stay invested in, through market cycles. The correlations between risk and return are just as high in good markets as it is in bad markets. These trying market conditions, however, allow for us to reassess our own risk appetite and the suitability of the current portfolio and asset allocation. 

While we all want to hear the secret recipe for beating the markets all the time, we know that sadly there is no such thing and sticking to a well-diversified, well-calibrated and strategic asset allocation investment strategy that is suitable for each investor is the best way to weather through the ever-changing market environment, the year of the Tiger or not.

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