Newsletter | March 2020

THE FEDERAL RESERVE MAKES A 0.5% EMERGENCY RATE CUT TO A TARGET RANGE OF 1% - 1.25%

0.80% THE 10-YEAR U.S. TREASURY YIELD AT AN ALL-TIME LOW IN EARLY MARCH

Investment perspective

If January was an eventful month, February proved to be much more dramatic as virus fears gripped the markets. Equities ended the month in freefall and the slide of bond yields accelerated. During the last week of the month, the 10-year Treasury yield dropped by a whopping 32bps to fast close in on the psychological level of 1%, whereas the major equity indices fell by around 12%, their worst weekly drop observed since the great financial crisis in 2008. The MSCI World Index, in local currencies, posted an 8.2% monthly loss. The 10-year Treasury and Bund yields fell by 36bps and 17bps respectively to end-February levels of 1.15% and - 0.61%. In the commodity space, oil prices dropped into bear market territory while technical factors prevented the price of gold from benefiting from the lower real yields and from a weaker dollar.

The end-February plunge of equity markets was extremely violent as it was the fastest US stock market correction in history; the S&P 500 dropped by 12.8% in just seven days of trading, wiping out over five months of gains, with the Dow Jones Index closing down by more than 1’000 points twice in a week. As was the case in December 2018, markets were totally driven by sentiment and a self-fulfilling negative spiral relentlessly drove prices lower. The dollar was another asset that was badly impacted by the end-of-month events. The collapse of Treasury yields and high Fed rate cut expectations were the main drivers for the sudden depreciation of the dollar as it rapidly lost more than 2% against the euro, from 1.079 dollars per euro on February 20 to 1.103.

The impact of the coronavirus on economic data is only starting to produce its effects; Chinese official and Caixin PMI Manufacturing numbers for February have plunged to levels well below those observed during the financial crisis. Upcoming data worldwide will increasingly reflect the contraction of business activity, reduced travel and supply chain disruption.

Investment strategy

The outbreak of the COVID-19 virus represents a totally unexpected and unforeseeable event, otherwise known in capital markets as a black swan event. We are not qualified to be able to predict the final outcome of the virus outbreak but things are likely to get worse before they get any better. Following the violent end-of-February correction of equity markets, the first week of March looks more like a roller-coaster with huge swings in both directions; it is likely that it will take some time for markets to stabilize.

In view of this extreme level of uncertainty, we have decided not to cut our equity allocation but to buy some protection. This tactical decision allows us to maintain our equity exposure which is based on our long-term outlook. It also contributes to mitigate portfolio losses were the ultimate impact of the virus outbreak prove to be much more damaging to the economy and to financial markets. Were markets prove to be resilient, the purchase of this protection will represent an opportunity cost for the portfolios, a limited price to pay in view of the potential drawdown of equity markets in a worst-case scenario.

MARKETS ARE HAVING TO FACE AN INCREASING LEVEL OF UNCERTAINTY

Portfolio Activity/ News

Following a strong rebound of risky assets during the first half of February, the remainder of the month proved to be much more hurtful to the performance of the portfolios. Only a small number of positions produced positive contributions; it was nevertheless reassuring to observe that some hedge funds ended with monthly gains. All equity funds ended in negative territory, unsurprisingly. Japanese equities were the worst detractors while emerging markets’ ones fared better in relative terms; we still believe that the valuations and the upside potential of both asset classes will be supportive when markets eventually regain their composure. The drop of most credit funds was contained in view of the widening of credit spreads, especially as a result of lower risk-free rates.

At the very beginning of March, we took advantage of a strong bounce of US equity markets to strengthen the portfolios by purchasing an end of June S&P 500 Put. The impossibility to predict the ultimate impact of the spreading of the COVID-19 virus on economic activity and on corporate earnings in the upcoming months led us to buy protection.

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News Flash | March 3rd 2020

Following our news FLASH published last Friday, the rebound of equity markets has been most welcome.

Equities got off to a strong start this week, with a 5% gain for US equities on Monday as well as an initially positive reaction to the Federal Reserve’s announcement to cut rates by 0.5% today; while anticipated by the markets, the FED’s decision has been taken exceptionally before the planned 18th March meeting and reflects the high level of concern of the US central bank in view of the spreading of the Covid-19 virus.

This equity bounce has provided us with a window of opportunity to strengthen portfolios and we have bought some protection at a cheaper cost than during last week’s sell-off. This tactical decision allows us to maintain our equity allocation. It also contributes to mitigate portfolio losses were the ultimate impact of the virus outbreak prove to be much more damaging to the economy and to financial markets. If markets were to prove resilient to the ongoing crisis and be little affected, the purchase of this protection will represent an opportunity cost for the portfolios, a limited price to pay in view of the potential drawdown of equity markets in a worst-case scenario.

The spreading of the virus will continue to trigger decisions by governments and corporations that will further hurt economic growth and raise the chances of a recession. The impact of these measures is impossible to predict, hence our decision.


News Flash | 28 February 2020

Since the middle of February, equity markets have been rattled by fears over the potential impact of the coronavirus on economic activity and on corporate earnings. Major indices have plunged by around 13% this week and one must go as far back as the financial crisis in October 2008 to observe a worse weekly correction, reflecting the severity and the velocity of the recent move; year-to-date performances of the major indices now range from - 6% (Nasdaq Composite) to -12% (Japan Topix). Market sell-offs are inherent to the equity asset class and historical analysis shows that these corrections have resulted in an average decline of 13% for the S&P 500  since WW2; to try to time such moves is a fool’s game and the latest sell-off has also likely been compounded by profit-taking on richly valued equities following a strong rally, technical selling and month-end rebalancing.

The current behaviour of markets is quite similar to the one observed at the end of 2018; they are being totally driven by sentiment and a self-reinforcing negative spiral appears to be setting in. We consider that they are becoming irrational as the ultimate fallout from the coronavirus is impossible to predict; the impact of this exogenous shock will impact economic activity in the first quarter severely but is likely to prove to be only temporary, like many times before.

We are fundamental long-term investors and are preparing to take advantage of attractive opportunities in a number of sectors and stocks that would result from an overshoot of this market correction; this would take our current neutral equity allocation to overweight. We are also paying particular attention to corporate credit in view of extended valuations and eventual unintended consequences and the uncovering of unknown issues due to leveraged balance sheets.

As always we reserve the right to change our investment outlook and to adjust our asset allocation according to the evolution of the situation and as governments and corporate leaders continue to react to the spreading of the coronavirus.


Newsletter | February 2020

APPLE’S $1.4 TRILLION MARKET CAP SURPASSES THE WHOLE VALUE OF GERMANY’S DAX

1.50% THE 10-YEAR U.S. TREASURY YIELD NEARS ITS 2019 LOW

Investment perspective

January was an eventful month which ended with equity markets declining and with bond yields tumbling. The MSCI World Index, in local currencies, dropped by only 0.3% but this performance does not reflect the dispersion observed across the different regions; the resilience of US equities resulted in a modest 0.2% loss for the S&P 500 whereas the MSCI Emerging Market Index lost 4.7%. The 10-year Treasury and Bund yields fell by 41bps and 25bps respectively to end-January levels of 1.51% and - 0.44%. In the commodity space, prices were much weaker, with energy ones being hit particularly hard, while the price of gold logically appreciated on the back of falling bond yields.

Despite their monthly declines, equity markets proved to be resilient. They have already had to face an escalation of geopolitical tensions in the Middle East as well as the outbreak of a fast-spreading acute respiratory syndrome in China. These events failed to push equity prices significantly lower even if the levels of technical indicators showed that markets were overbought and in need of a breather. US growth stocks have continued to lead the way and were helped by the reporting of better-than-expected Q419 earnings. Out of the 300 S&P 500 companies having already reported their fourth-quarter earnings, 74% have reported positive earnings’ surprises, with EPS (earnings per share) on track for a YoY growth of 3% compared to expectations of 1.9%. The reporting of European companies has also been supportive, with 55% posting positive sales surprises and 58% better-than-expected earnings.

Sovereign bond markets appear to reflect a more cautious outlook than equity markets. In relative terms, the decline of government bond yields in January exceeded the limited drawdown of equities and yields have not rebounded back to their early-year levels; in contrast, equity markets have rallied at the beginning of February and are back in positive territory.

The early-year spike of oil prices, due to the escalation of US-Iran tensions, seems like a very distant memory. The chart shows that prices have since fallen by more than 20% as a result of concerns about a slowdown in oil demand, on the back of the coronavirus outbreak. According to Bloomberg, Chinese oil demand has dropped by around 3 million barrels a day, or 20% of its total consumption. Reports that Saudi Arabia was pushing OPEC and its allies for another cut in crude production failed to provide support for prices.

Investment strategy

As a reminder, we have started 2020 with a more dynamic positioning of the portfolios. In December, we had boosted the equity exposure to an overweight allocation and also added a high-octane emerging market corporate debt fund to the fixed-income asset class. This meant that we were carrying more risk in view of our constructive view on the global economy and on market conditions.

The outbreak of the coronavirus in the city of Wuhan, the capital of Central China’s Hubei province, was an exogenous and unpredictable event; its ultimate impact is difficult to assess, but it will clearly affect China’s first-quarter GDP, in spite of various supportive measures taken by the Chinese authorities. We nevertheless decided not to change the structure of the portfolios as we did not anticipate a severe drawdown of equity markets. At the time of writing, markets have recovered their positive trend and appear to be in agreement with our bullish view.

MARKETS HAVE SHOWN RESILIENCE IN FACE OF THE CORONAVIRUS

Portfolio Activity/ News

January turned out to be quite a frustrating month as the portfolios had been performing well until the outbreak of the coronavirus in China. Unsurprisingly, emerging market and Asian exposures figured amongst the portfolios’ largest detractors, whereas US growth stocks and US small caps produced significant contributions as did longer duration and convertible bonds. Two Japanese equity funds were hit particularly hard, unfairly in our view, and we continue to see value in this asset class. The new emerging market corporate debt fund, which had been approved in December, fared well and ended the month up by 2% in dollar terms.

Both convertible bond funds produced positive monthly returns and we consider this asset class to be a very attractive proposition in the current market conditions. It is also interesting to observe the differences between the market structure of the different regions. European convertibles generally have a higher credit rating and tend to be issued by more established companies whereas US ones are often rated high-yield and issued by faster growing companies in sectors such as technology and biotech.

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Newsletter | December 2019

THE FED’S BALANCE SHEETHAS GROWN BY $293 BILLION SINCE THE END OF AUGUST

5.5% ONE-YEAR EURO/DOLLAR VOLATILITY REACHES A RECORD LOW

Investment perspective

November was a strong month for the equities of developed markets as the MSCI World Index, in local currencies, climbed by 3%. De-escalating trade tensions, merger and acquisition activity, accommodative central banks and some improving economic data contributed to push equity prices higher. In contrast, emerging market equities lagged significantly, partially due to a stronger dollar and to ongoing political tensions in Hong Kong and across other regions. Whereas EM equities initially rose on optimism over a “phase one” trade deal between the U.S. and China, they dropped subsequently and diplomatic tensions gradually resurfaced as Washington passed two bills supporting protesters in Hong Kong. Bond yields rose steeply during the first third of November with investors reducing exposure to safe haven assets; as a result the yield on the 10-year Treasury bond climbed from an end-October level of 1.69% to 1.94% before retreating to end the month at 1.78%.

The year-to-date equity rally has been quite remarkable and been driven, in large part, by the combined support of central banks across the world, as the growth of corporate earnings has tended to be anaemic. This has resulted in a significant re-rating of equity valuations and investors will be hoping that the recent pick-up of economic data will be followed by a sustainable, even if modest, rebound of economic activity in the months ahead; such an environ- ment would contribute to boost the prospects for 2020 earnings and justify some of the optimism currently priced in equity markets.

Capital markets appear to be sanguine about the upcoming UK elections which are taking place on December 12th. The pound has been appreciating as the latest polls are indicating a lead of around 10% for Conservatives over Labour; if confirmed, this could mean a majority for Boris Johnson’s party and a better chance of unblocking the current stalemate on Brexit.

 

Investment strategy

Following the performance of equities in October and November, our allocation towards equities is now close to being neutral. Our assessment that global equity markets are looking expensive in absolute terms and that a lot of positive news is already discounted hasn’t changed, but the lack of more attractive asset classes means that equities could well continue to appreciate. The fact that economic data has started to show some signs of improvement will also encour- age investors to buy more shares, so we are maintaining our neutral allocation for the time being.

Our equity exposure is well diversified across the different regions and the different strategies, but we currently see stronger upside potential in certain areas; Japanese growth stocks appear well positioned to outperform the broader Japanese market due to low valuations and better earnings prospects while small caps could also perform well if signs of a recovery were to be confirmed. The equities of emerging markets are also attractive based on their valuations and on their catch-up potential relative to developed markets.

MARKETS REMAIN VERY SENSITIVE TO ANY TRADE-RELATED NEWS

Portfolio Activity/ News

November was a good month for the portfolios, largely the result of strong equity performances. The best contributions were provided by U.S. Small Caps and U.S. Value stocks as well as by the Healthcare sector fund. Several other equity funds also produced valuable returns while the detractors were few and far between. The early-month rise of bond yields did not last and the bond funds with longer durations suffered only minor monthly drawdowns. The alternative allocation made a modest positive contribution as did the dollar exposure for non-USD denominated portfolios.

We have recently added a new European Small Cap fund to our list. The fund’s management team has been investinginto the European small cap universe for many years as well as into the micro cap space; this knowledge of micro caps offers an additional source of investment ideas for the Small Cap fund. The fund has generated an outstanding track- record compared to peers and to its benchmark; it can also be qualified as being a genuine Small Cap fund in terms of the market capitalisations of the underlying positions; the fund has a 1.6bn EUR average weighted market cap vs. 3.1bn EUR for its peer group.

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Newsletter | November 2019

THE U.S. BUDGET DEFICIT HAS TOPPED $1 TRILLION SO FAR THIS YEAR

+ 5.3% THE BEST MONTH FOR STERLING/DOLLAR PARITY IN A DECADE

Investment perspective

Following a rocky start to the month, global equity markets ended October with gains. The MSCI World Index, in local currencies, appreciated by 1.8%, and Japanese equities continued to outperform. Markets were dominated by a de-escalation of trade tensions, the reporting of Q3 earnings and Brexit events which all contributed to an improvement of investor sentiment. The S&P 500 managed to record a new all-time high, but with a certain lack of conviction, in view of the low volume of traded shares and the narrow breadth of the market. Sovereign debt yields moved higher during most of the month until the last trading sessions saw them reverse on renewed trade concerns and on weak U.S. economic data. The U.S. dollar depreciated against most currencies, largely the result of optimism over trade talks.

The October meeting of the U.S. Federal Reserve produced the expected outcome in terms of its benchmark reference rate, i.e. another 0.25% cut to a range of 1.50% to 1.75%. The less predictable part was how the central bank would communicate on its outlook for monetary policy. The Fed turned out to be more hawkish than expected as it signalled an end to its recent easing cycle. Fed Chairman Powell stressed that the current stance of monetary policy would be appropriate as long as incoming information remainedconsistent with the bank’s outlook. However, Powell also made it clear thattightening was very unlikely in view of below-target inflation.

Companies have been busy reporting their earnings for the third quarter and, overall, this has proved to be supportive for equity markets. With 351 out of 500 S&P 500 companies having already reported, 70% have beaten profit estimates and 60% revenue estimates. In Europe, 55% of companies have produced positive earnings surprises and 60% positive revenue surprises.

 

Investment strategy

Global equity markets have continued to edge higher despite the ongoing slowdown of economic growth and the absence of signs of any upcoming improvement. On the other hand, the risks of a recession still appear as being quite low, mainly thanks to the resilience of consumers, while trade tensions have declined. In this environment, investors are taking the view that markets are benefiting from a Goldilocks scenario, with modest, even if slowing growth, and central banks providing monetary support thanks to rate cuts and to an accommodating bias. At the risk of missing out on some potential upside until year-end, we maintain our modest underweight allocation towards equities. We view the cur- rent trend for equities as one that is lacking conviction and consider that a lot of positive news is already priced in.

The euro has recently appreciated against the U.S. dollar but we do not foresee further significant upside at this stage. So far this year currency volatility has been low and the major FX crosses have not changed much. Our allocation towards the dollar remains underweight.

EQUITIES ARE CLIMBING THE WALL OF WORRY BUT ARE STILL LACKING CONVICTION

Portfolio Activity/ News

The portfolios ended October slightly higher thanks largely to the positive performances of equity positions. The rebound of bond yields meant that the overall contribution of the fixed-income asset class was close to neutral. The global contribution of alternative investments was detrimental as trend-following, Global Macro and Risk Premia strategies ended with small negative performances. For a second consecutive month, the best contribution was provided by our U.S. value fund which continued to benefit from the regained interest for value stocks. Japanese and emerging markets equities also fared well as they made up some of their year-to-date underperformance.

We added a new short duration credit fund to the portfolios in October. The strategy of the fund is based on a diversified portfolio of credit instruments and composed of three sub- strategies: carry (buy-and-hold), market timing (trading in new issues) and derivative strategies (pair trades, creditcurve, capital structure...). The track-record of this fund since its inception has been outstanding and it ended 2018 with a gain, quite an achievement in a very challenging year. The main purpose of this fund is to offer a low-risk alternative to cash for portfolios denominated in euros and Swiss francs.

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Newsletter | October 2019

THE GLOBAL STOCK OF NEGATIVE-YIELDING DEBT REACHES $17 TRILLION

10% THE OVERNIGHT REPO LENDING RATE SPIKES

Investment perspective

Risky assets fared well during September as trade tensions eased somewhat. The MSCI World, in local currencies, appreciated by 2.2%, with Japanese and European equities outperforming, whereas government bonds pared back some of their strong year-to-date gains. Gold was also in consolidation mode as a result of higher yields and of a firmer U.S. dollar. The past month wasmarked by a major attack on Saudi Arabia’s oil infrastructure which triggereda spike of oil prices; this proved to be only temporary however as the release of strategic reserves and a faster-than-expected recovery of production then pushed prices below their end-August levels. Politics continued to be a key driver for markets; the formation of a new coalition government in Italy and a series of defeats for Boris Johnson’s U.K. government, deemed as reducing the chances of a no-deal Brexit, were taken positively by investors.

The September meetings of the European Central Bank and the U.S. Federal Reserve were highly awaited by the markets. The ECB decided to cut rates by 0.1% to - 0.5%, to restart QE (€20 billion per month) and to introduce “tiering”for banks in order to limit the impact of negative rates on their profitability. The ECB will also offer banks new TLTROs (targeted long-term financing) with favourable terms. On its side, the Fed cut rates by 0.25% to a range of 1.75%to 2% but said that it didn’t expect further rate cuts this year. Members of theFederal Open Market Committee (FOMC) were much divided on the bank’snext move, with seven members wanting at least one more reduction in 2019.

The global stock of negative-yielding debt surpassed $17 trillion at the onset of September. According to Bloomberg, thirty percent of all investment-grade securities are trading with sub-zero yields, including corporate bonds. With global economic growth slowing and central banks back in easing mode, this stock of negative-yielding debt could well keep on expanding.

Investment strategy

Since the beginning of the year, the consensus of the market anticipated an improvement of the global economy in the second half of the year. This optimistic scenario has been in- creasingly put into doubt as macroeconomic data has failed to show signs of a rebound. We have been quite surprised that markets have brushed these concerns aside so easily and placed so much faith in the ability of central banks to offer sufficient additional support to extend the economic cycle. Indications that the so-far resilient consumer sector is also starting to show some weakness would likely only amplify the current growth concerns. The upcoming reporting of third- quarter corporate earnings is likely to focus on the impact of the economic environment on capital investment and on the outlook for future earnings. These factors largely explain why we are sticking to a more cautious portfolio positioning as we look to protect strong year-to-date gains.

As we had expected, bond yields rebounded from their year- lows as investors took some profits and the bond rally had clearly been overbought. However a big rise of bond yields is not our main scenario, in a context of softening economic activity and of easier monetary policies.

ECONOMIC WEAKNESS LIKELY TO WEIGH MORE ON MARKETS

Portfolio Activity/ News

The portfolios ended September higher thanks to the positive performances of equity positions. The rebound of bond yields meant that the overall contribution of the fixed-income asset class was close to neutral. The past month’s best contributionwas provided by our U.S. value fund which benefited from the rotation out of momentum and growth stocks into deep value ones. It is still too early to know whether this shift will prove just to be a temporary trend or a more sustainable one, but what is certain is that value stocks are trading at a record discount compared to growth stocks. Our allocation into Japanese equity funds was another strong contributor in view of the monthly outperformance of Japanese equities. The much discussed trend-following strategy was the biggest detractor in the portfolios as it suffered from the impact of rising bond yields, but still stands around + 20% YTD.

We added a defensive global equity fund to the portfolios in September. The fund has a value approach and its current defensive positioning is reflected by a significant exposure to cash and to gold. At a time when certain market factors appear to be running out of steam, the fund could benefit from renewed demand for value stocks and from a normalisation of bond yields.

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Newsletter | September 2019

+ 18%: THE PERFORMANCE OF GOLD IN 2019

1.50% THE END-AUGUST YIELD ON 10-YEAR U.S. TREASURIES

Investment perspective

The month of August proved to be much more volatile, largely thanks toDonald Trump’s Twitter activity going into overdrive; according to the New Yorker, Trump tweeted six hundred and eighty times during the month. Equity markets reacted to all kinds of headlines, at times violently, as trade tensions between the U.S. and China ratcheted up to another level and as political risks spiked across the world; markets were also weighed down by recession fears as the closely-observed 10-year/2-year Treasury yield curve briefly inversed. Global equities recorded four consecutive negative weekly returns before staging a rebound at the end of the month. The decline of high-quality sovereign debt yields accelerated, with that of the 10-year U.S. Treasury note dropping by 0.52% to 1.50%, its lowest level since July 2016, while the yield on 10-year Bunds reached a new all-time low of - 0.72%.

Once again, the tweeting activity of Donald Trump had a major impact on the capital markets; in early August, the U.S. President announced 10% tariffs on $300 billion worth of imports from China, up to then not subject to levies. This triggered a drop of the Chinese yuan in retaliation and the tensions between both countries continued to intensify. Trump was also very busy attacking the chairman of the Federal Reserve, Jerome Powell, whom he referred to as“clueless Jay Powell” and whom he accused of a “horrendous lack of vision”.As often in the past, when markets had been under pressure, Trump adopted a more conciliatory tone towards China later in the month, which contributed to equity markets regaining part of their August losses.

Another issue often mentioned during August was the possibility that fiscal stimulus could increase significantly, especially as the monetary policies of the main central banks appear to be reaching their limits. The fact that German officials openly talked about what kind of fiscal support they could introduce was very revealing of the impact that the downturn of the economy is having.

 

Investment strategy

During the summer, we maintained our disciplined approach as we stuck to our relatively defensive asset allocation and even added some equity protection. Over the recent period we have observed rising market volatility, another flare-up of political risks in Europe and higher trade tensions at a time when data has been showing economic weakness. Rather than betting on strong support from central banks and on a positive resolution to the U.S.-China trade conflict, we prefer to err on the side of caution and maintain our underweight equity allocation. This stance is also explained by our focus on active risk management in a context where year-to-date performances have exceeded most of our expectations.

The trend of bond markets has continued to reflect rising concerns over recession risks and anticipations of further rate cuts by the major central banks. While we agree that the weakening of economic data justifies part of the recent rally of bonds, we think that it has likely overshot and would ex- pect a rebound of yields in the near term.

WE MAINTAIN OUR UNDERWEIGHT ALLOCATION TOWARDS EQUITIES

Portfolio Activity/ News

In August the portfolios ended in negative territory but the late-month rebound of global equity markets meant that the monthly drawdown was limited. The best contributions were provided by fixed-income exposures as well as some hedge funds, in particular the trend-following strategy, thanks to its high exposure to rates. The steep decline of bond yields was the main driver for long duration fixed-income funds, with some reaching double-digit year-to-date performances, quite an achievement! Most of our equity funds outperformed their benchmarks and ended with positive monthly returns. Amongst the laggards, the U.S. value and Japanese growth positions fared the worst.

During the summer, we protected the portfolios by buying a put warrant on the S&P 500 Index. This was carried out at a time when volatility was cheap, enabling to limit the cost of this transaction. The main interest of this put warrant is thatit has a “lookback” feature, meaning that its 95% strike will be fixed at the peak level of the index during the lifetime of the warrant. In the case of an equity rally followed by a correction, this solution would offer much better protection than a plain vanilla put where the strike is never ajusted.

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Newsletter | June 2019

- 17%: THE PERFORMANCE OF THE PHILADELPHIA SEMI- CONDUCTOR INDEX IN MAY

2.06% - THE EARLY-JUNE YIELD ON 10-YEAR U.S. TREASURIES

Investment perspective

The four-month rally of global equity markets came to a screeching halt in May. The early-year optimism over a trade deal between China and the U.S. gave way to concerns over a major breakdown of trade talks and growing fears of an economic slowdown. The prices of risky assets depreciated across the board; the MSCI World Index in local currencies fell by 6%, the spreads of credit and emerging market debt widened and commodity prices weakened, with oil down by 16%. Significant flows into safe-haven assets contributed to strong returns for high-quality sovereign debt, gold and defensive currencies such as the yen and the Swiss franc. The yield of the 10-year U.S. Treasury note declined by 0.38% to 2.10%, its lowest level since September 2017, while the yield on 10-year Bunds reached an all-time low of - 0.21%.

Once again, the tweeting activity of Donald Trump has been a major driver of financial markets; the U.S. President blamed China for trying to renegotiate certain terms, placed restrictions on business between U.S. companies and Huawei, decided to delay tariffs on European automakers and finally added new tariffs on imports from Mexico. The latter decision came out of the blue, with tariffs gradually rising if Mexico did not help to limit the flow of migrants. The 2020 re-election has started in earnest, with Trump seeing a multi-front trade war as a good way to play to his political base. For market participants, the rise of uncertainty makes the outcome of investment decisions much less predictable, hence the shift towards more defensive assets.

Apart from trade headlines, global macroeconomic data did not provide much support to the markets as forward-looking indicators tended to disappoint, in the U.S. in particular. The outcome of the much-awaited European elections was taken in its stride by the markets as the worst-case scenario was avoided; gains made by populist and far-right parties failed to match projections and the new European parliament will reflect the fragmentation of politics which has already been observed in many European countries.

The month of May was dominated by headlines over trade talks and a U.S. ban on the Chinese tech giant Huawei, limiting the business U.S. companies could do with it. This ban had a ripple effect on the whole technology sector, with semiconductor companies being the most severely impacted. The chart above shows that the reference Philadelphia Semiconductor Index fell by 17% in May, its worst monthly performance since November 2008.

 

Investment strategy

We are sticking to our relatively defensive asset allocation in view of a rising level of uncertainty and concerns over weaker economic data. We will not pretend to have been expecting such a steep reversal of equity markets, but we had felt that they were pricing in an overly optimistic scenario. We observe that markets are once again looking for some help from the Federal Reserve and that the odds of a Sino-American trade deal in the short term have significantly lengthened. In this environment, it is difficult to justify adding more risk to the portfolios and we therefore maintain our underweight equity allocation.

The recent trend of bond markets has been quite dramatic, in view of the collapsing yields, as has been the significant shift in expectations on rate cuts by the Federal Reserve. Markets are now pricing in a 55% probability for 3 rate cuts of 0.25% this year, compared to a 2% probability only a month ago! The market’s divergence with the position of the central bank is becoming quite extreme and the Fed will need to tread carefully to manage the growing pressure from the markets.

WE MAINTAIN OUR UNDERWEIGHT ALLOCATION TOWARDS EQUITIES

Portfolio Activity/ News

In May the portfolios gave back some of their strong returns recorded during the first four months of 2019. This resulted mainly from weak equity markets and from a widening of credit spreads. The more defensive fixed-income positions ended in positive territory while the best contribution was provided by the trend-following strategy, thanks to its high exposure to rates. In relative terms, most equity funds fared better than their benchmarks, with only some exceptions. Our fund investing into U.S. value companies was the largest detractor as it lost all of its early-year outperformance. Despite this setback, we maintain our confidence in the manager and have topped up positions in some portfolios.

The latest addition to our list of funds is an “out-of-the-box”Swiss franc bond fund investing into investment grade quality. The distinctive feature of this fund is that it invests both into higher duration top quality bonds and into up to a maximum of 30% of global investment grade convertiblebonds; this “barbell” approach enables the fund to benefit from its higher duration and top quality in risk-off periods and from its equity sensitivity when equities are rising.

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Newsletter | May 2019

+ 27%: THE PERFORMANCE OF THE U.S. TECHNOLOGY SECTOR IN 2019

2’946 - THE S&P 500 CLOSES APRIL AT A NEW RECORD HIGH

Investment perspective

The rebound of global equity markets was extended in April with European stocks outperforming and U.S. indices reaching new records. The MSCI World Index in local currencies gained 3.6% during the month to bring its year-to- date performance to 16%; growth stocks outperformed value ones, with the technology sector faring the best, on the back of well-received first quarter earnings. The strong demand for risky assets was also reflected by tighter credit spreads and by the weakness of the Swiss franc, which depreciated by 2.4% against the euro and the U.S. dollar. The rally of G-7 sovereign debt came to a halt as yields moved higher, even if this rise remained modest when compared to the plunge of yields over the last quarters.

Companies have been busy reporting their earnings for the first quarter and, overall, this has proved to be supportive for equity markets. With 290 out of 500 S&P 500 companies having already reported (73% of the index’s marketcap), 75% have beaten profit estimates and 52% revenue estimates. Analysts had significantly downgraded their earnings’ expectations, especially for the technology sector, so the beat rate must be seen in that context. The results of many tech giants were well received by investors, nevertheless, and companies such as Microsoft, Amazon, Facebook and Apple saw their stock prices trade up and push indices higher.

Global macroeconomic data continues to be mixed but improvements have been observed in the Eurozone and Chinese economies. Euro-area GDP for the first quarter showed a brightening picture, while the latest data in China suggest that policy measures are starting to bear fruit. The initial estimate of U.S. Q1 GDP was 3.2%, above forecasts, but it was driven by two of the more volatile components of GDP, inventories and exports. In contrast, household consumption and fixed investments only rose by 1.2% and 1.5%, respectively, signalling that U.S. GDP growth could slow in the next quarters.

The recovery of global equity markets in 2019 has been spectacular and the chart shows that the S&P 500 Index is back into record territory. After briefly dropping below 2’350 in late December, the index has rebounded by morethan 25% and erased all of its fourth quarter losses. It is interesting to note that the index has been driven by cyclical sectors, with the IT-heavy Nasdaq Composite Index up by 22%, compared to a 14% gain for the Dow Jones Index.

Investment strategy

Following the two-phase shift of our equity allocation from overweight to underweight since the beginning of the year, there have been no changes to our asset allocation in April. That means that portfolios are holding an above-average level of cash, while our fixed-income allocation is still under- weight. As a reminder, our investments across the asset class are well diversified, including unconstrained fixed-income strategies, investment-grade and high-yield bonds, senior secured loans and convertible bonds. Our cautious equity positioning reflects a macro-economic environment that is unlikely to benefit from any significant pick-up of growth, and equity markets already discounting a lot of positive news; wealso have some concerns about earnings’ expectations forthe remainder of the year in a context of slower growth.

For the majority of portfolios, we have not been exposed to gold for some time but it is obviously one amongst the many assets that we continuously monitor. Its recent price decline still leaves it some distance away from our target of around $1’200 per ounce, but we would not exclude the possibility that the precious metal could make a comeback within the portfolios at some stage.

WE MAINTAIN AN UNDERWEIGHT ALLOCATION TOWARDS EQUITIES

Portfolio Activity/ News

In April, the portfolios continued to appreciate, largely the result of strong equity contributions. Fixed-income positions all ended in positive territory and added more modestcontributions to the portfolios’ performance. Within thealternative space, the trend-following strategy maintained its positive momentum to record another valuable monthly gain. U.S., European, emerging markets and Japanese equity funds all produced noteworthy returns relative to their respective benchmarks; when looking at year-to-date performances, it is reassuring to observe that a majority of our funds have produced significant alpha.

We added a new healthcare fund to our list of approved funds. This fund invests in companies active in the medical technology and healthcare services sector, but excludes drug makers. Healthcare represents 10% of global GDP and is an above-average growth sector which benefits from favorable demographics and the rise of global prosperity. Digital health, minimally invasive technologies, gene-based diagnostics and managed healthcare concepts figure amongst the principal themes that the managers will invest into. In our model portfolios, this fund has replaced a defensive global equity fund.

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