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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Newsletter | April 2019

+ 12%: THE BEST QUARTER FOR THE MSCI WORLD LC INDEX SINCE Q3 2009

- 0.07% - THE YIELDS OF 10-YEAR BUNDS ARE BACK INTO NEGATIVE TERRITORY

Investment perspective

The first quarter has ended with a well above-average quarterly gain for global equity markets, a significant contraction of credit and EM debt spreads and a plunge of sovereign debt yields. It has also seen the main central banks turn increasingly dovish in the light of growth slowdown concerns and a lack of inflation pressures. Following a 13.5% correction during last year’s fourth quarter, the MSCI World Index in local currencies has made up most of its losses thanks to a 12% year-to-date rebound. Credit spreads have also fared well, with those of U.S. and European high yield bonds tightening by 1.35% and 1.09% respectively. These trends have been primarily driven by the unwinding of excessively pessimistic sentiment, the Federal Reserve’s change of tone and optimism over a sino-american trade deal.

The past month was marked by the steep drop of bond yields in a context of weak economic data and the announcement of even more accommodative monetary policies. PMI Manufacturing data continued to show widespreadweakness, in Europe in particular, with Germany’s number dropping to 44.1from 58.2 a year earlier; one must nevertheless point out that China’s latestmanufacturing data has started to show signs of improvement. At its last meeting, the Federal Reserve proved to be even more dovish than expected by the markets; the bank announced the end to its balance sheet reduction for 30 September and its members no longer anticipate any rate hikes this year. Furthermore, it downgraded its GDP growth outlook for 2019 from 2.3% to 2.1%. On its side, the European Central Bank had already spooked markets at the beginning of March due to its bleaker economic outlook and by the announcement of a number of measures to support the Eurozone’s economy. These more dovish stances triggered much lower bond yields, with those of 10-year Treasuries and Bunds dropping from end-February levels of 2.72% and 0.18% to 2.41% and - 0.07% respectively.

One of the most hotly debated issues in financial markets is the current shape of the U.S. yield curve. The chart above shows that it is now partially inversed, as some longer-term yields are lower than shorter-term ones. The inversion of the yield curve is seen as a forward indicator of an upcoming recession, even if there is no consensus over which terms’ spread is the most relevant. We can observe that neither the 10/2 years spread nor the 30Y/3months spread have inverted and conclude that it is still premature to get overly concerned.

Investment strategy

In March we decided to take additional profits on equities, meaning that our equity allocation has been cut this year from an initial overweight to now being slightly underweight. This decision was driven not only by the desire to protect some of the strong year-to-date portfolio performance but also by the feeling that markets might be getting carried away. A lot of positive news appears to be priced in at a time when global GDP growth is slowing and when uncertainty over corporate earnings is high. The markets also appear to be totally ignoring the risks related to a no-deal Brexit. We therefore prefer to err on the side of caution ahead of the reporting of first quarter earnings, which starts mid-April.

The first quarter has been quite exceptional in terms of performance as both equity and bond markets have rallied simultaneously. We do not believe that this situation will last and expect a decrease of the correlation between both asset classes going forward.

WE HAVE OPTED FOR MORE CAUTION IN THE PORTFOLIOS

Portfolio Activity/ News

In March, the portfolios added to their early-year gains, with both equities and bonds contributing positively. In contrast to the previous months, the overall contribution from hedge funds was also positive. This was mainly due to the strong return recorded by the trend-following strategy, which benefited from its high exposure to long-term rates, to credit and to equities. Other strong portfolio contributors includedemerging and frontier markets’ equities, as well as bondfunds, especially those with a long duration positioning. Our underweight exposure towards the U.S. dollar represented a modest opportunity cost for portfolios denominated in euros and pounds, due to the weakness of these currencies.

During the past month, we took profits on our U.S. Small Cap fund and also on a fund investing into Swiss equities. The reasons for these transactions include strong year-to-date performance, portfolio risk management and the view that markets might be getting a little frothy in view of economic uncertainty and excessive optimism over the impact of the sino-american trade deal.

 

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Newsletter | March 2019

THE CHINESE CSI 300 INDEX RISES MORE THAN 30% BY EARLY MARCH

$621 billion - THE U.S. TRADE DEFICIT IN 2018, A 10-YEAR HIGH

Investment perspective

The positive trend for risk assets observed since the beginning of the year extended throughout February. The MSCI World Index in local currencies gained another 3.2%, bringing the year-to-date performance up to 11%. The spreads of credit and emerging market debt also continued to contract, with high-yield bonds now having erased most of their losses of November and December. Logically, the more defensive assets such as government debt and gold ended the month on a weaker note, with yields moving higher and the price of gold dropping back to its end 2018 level. The major currency crosses evolved within tight ranges to remain little changed so far this year.

The rising trend of equity markets was not derailed by macro-economic data that showed ongoing weakness, in Europe and China particularly. There has been, nevertheless, some signs of improvement recently, with PMIs appearing to trough and confidence indicators also rebounding. The positive sentiment within markets was supported in part by additional liquidity provided by the central banks this year, but also by more optimism over the negotiations between the U.S. and China, with Donald Trump extending the March 1stdeadline for an increase of tariffs. For obvious reasons, both countries appear intent on reaching an agreement, even if it did not immediately resolve all the issues. The end of the reporting of 4Q earnings was another factor that has proved to be overall supportive for equities, as a majority of companies were able to beat lowered expectations.

The ECB has just announced that it would keep interest rates on hold until at least the end of the year; it will also provide another round of cheap lendingfor Eurozone banks due to start in September. This reflects the central bank’s increasing concern about the strength of the Eurozone economy as it now projects GDP growth of 1.1% this year, revised down from 1.7% previously.

The chart above shows that the Shanghai Shenzen CSI 300 Index has got off to a strong start in 2019 following last year’s 25% correction. Chinese equities figured amongst the worst performers in 2018, amidst an economic slowdown and trade tensions with the U.S. The early year rebound has been supported by strong international inflows, a series of stimulus measures taken by the Chinese leadership, additional central bank liquidity, and optimism about a trade deal as well as by valuations which had become excessively cheap.

Investment strategy

We recently reduced our overweight equity allocation to neutral as markets appeared to be overbought. The strong move of equities this year, as well as high alpha generated by some funds, have provided a good opportunity to lock in some profits. A lot of positive news has been priced in and we expect markets to take a breather at this stage, especially as the valuations of U.S. stocks are back in line with long- term averages. There is a risk that markets could focus more on concerns about future economic growth now that most companies have reported their results for the fourth quarter.

The decision of the ECB to turn even more dovish has taken the markets by surprise and, following an initial positive market reaction, the promise of more cheap funding has appeared to spook investors. Bond yields have dropped, equities are weaker and the euro has lost ground. We will be closely monitoring the behaviour of the euro due to our underweight exposure for non-USD portfolios.

EQUITY MARKETS AT RISK OF STALLING IN THE SHORT TERM

Portfolio Activity/ News

The portfolios performed well in February as they continued to benefit from supportive markets for risk assets. The main contributions were provided by a wide range of funds within the equity asset class, while convertible bonds and credit also added to the performance; hedge fund strategies proved to be modest detractors, which was to be expected considering their positioning. U.S. small caps and Japanese equities were the strongest contributors, thanks to significant generation of alpha relative to their benchmarks.

During the past month, we carried out a number of transactions. Firstly, we topped up some of our existing equity positions in emerging markets and Japan. In the wake of strong gains for equity markets since the beginning of the year, we also took some profits by top-slicing some out- performing funds, investing in the U.S. and Europe in particular. Finally we added a new credit fund with a flexible approach. The manager can invest into corporate bonds in a global manner, but can also position the portfolio much more defensively when market conditions deteriorate. The fund has a very strong track-record and managed to end 2018 with a positive performance in USD.

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Newsletter | February 2019

THE BEST JANUARY FOR THE S&P 500 SINCE 1987: +7.9%

- 103bps - THE TIGHTENING OF SPREADS ON U.S. HIGH YIELD IN JANUARY

Investment perspective

What a difference a month makes! For investors gripped by fear during the manic month of December, January provided a much-needed relief rally of risk assets. Global equity markets had their best month since October 2015, with a 7.7% gain for the MSCI World Index, and credit spreads dropped back to end-November levels, or even lower. Commodity prices also rebounded, lead by oil and industrious metals. In foreign-exchange markets, emerging markets and commodity-related currencies performed the best. In this environment, it is also worth noting the positive performance of more defensive assets, including government debt and gold.

The significant rebound of risk assets can be interpreted as un unwinding of market pessimism relative to the outlook for economic and earnings’ growththat had become extreme. The path of the Federal Reserve’s monetary policy was another concern that had been weighing on the markets during the fourth quarter; the significant early-January shift towards a more dovish stance proved to be one of the drivers of the recent rally; it also contributed to push government bond yields lower, especially as the European Central Bank adopted an increasingly more cautious tone. Some optimism on the progress of the U.S.-China negotiations on trade and structural issues also provided market support. Finally, the reporting of Q4 earnings, while not as impressive as previous quarters, has nevertheless seen markets react generally well to positive surprises.

In the meantime, macro-economic data continues to show widespread weak- ness across the Eurozone and in China, in particular in the manufacturing sector. Markit PMI Manufacturing readings dropped below the expansion level of 50 in both Germany and Italy, while the Chinese Caixin Manufacturing PMI fell further into contraction territory at a level of 48.3.

The chart above shows that the MSCI World Index nearly recovered all of its December drawdown in January. The exhaustion of selling within stressed equity markets was observed towards the end of 2018. This contributed to the early year rebound, from a starting point of extreme oversold conditions. The turnaround was helped in part by remarks from the Fed’s Chairman Jerome Powell about more flexibility in interest rate increases and about the possibility that the central bank could stop shrinking its balance sheet soon.

Investment strategy

Our assessment that the movements observed towards the end of 2018 were difficult to justify has been vindicated by the behaviour of financial markets in January. Our decision to maintain a modest overweight equity allocation at the onsetof 2019 has contributed to this year’s good start. It has also been reassuring to observe the rebound of credit markets which have recovered their December losses. Some of the market’s headwinds appear to be lifting and recession fears have decreased. At this stage however, equity markets look overbought in the short term and might need to consolidate.

Our exposure to the dollar for non-USD portfolios is under- weight as we believe that the U.S. currency is unlikely to be as well supported as last year. The much lesser impact of tax reform, a more dovish Fed, widening current account and budget deficits should all weigh on the U.S. dollar. In fact, this is one of the key factors for risk assets to be able to perform well this year.

FOLLOWING THEIR STRONG REBOUND, EQUITY MARKETS LIKELY TO CONSOLIDATE

Portfolio Activity/ News

January was a very good month for the portfolios as nearly all the underlying positions ended the month with positive returns. With only a few hedge funds recording modest drawdowns, the strong rebound of equity markets and the significant narrowing of credit spreads contributed to an above-average monthly performance. U.S. equity funds provided the best contributions, with small caps and growthstocks leading the way. One of last year’s laggards, a U.S. value fund, has also been outperforming its benchmark significantly. Emerging market equity funds were other noteworthy contributors while all the fixed-income funds ended the month with higher NAVs.

In January, we took the decision to redeem a fund investing into European Mid and Small Caps due to the decline of the size of its assets under management. We recently added a new fund which invests into Chinese equities. The Chinese market figured amongst the worst performing equity markets last year and valuations have reached levels well below long- term averages. Even if the Chinese economy continues to slow, many sectors are still offering attractive rates of growth. This market also presents a relatively low degree of correlation with other equity markets making the investment case for this region quite compelling.

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Newsletter | November 2018

THE WORST MONTH FOR THE S&P 500 SINCE SEPTEMBER 2011: -6.9%

10% EXPECTED EPS GROWTH FOR THE S&P 500 IN 2019

Investment perspective

October lived up to its reputation of being a volatile month for equity markets reflected by the 6.9% drop of the MSCI World Index, in local currency terms. The rout was wide spread as stock markets across the world were hit by fears over slowing growth, trade wars and higher interest rates. For once, American equities failed to offer any additional resistance than the other markets and a number of technology favourites, such as Amazon and Netflix, suffered from heavy selling. The fall of the equity market showed a lot of similarity to the one that took place in late January/ early February; equities suddenly dived following a period of fast rising Treasury yields whereas safe haven assets did not benefit that much from the sell off; 10-year Treasury yields ended the month 8bps higher and the price of gold appreciated by less than 2%.

The reporting of U.S. corporate earnings for the third quarter of 2018 canhardly be blamed for the equity market’s poor behaviour even if there was some concern expressed over the forward guidance of certain companies. With more than 400 S&P 500 companies having reported, 82% have beaten profit estimates and 61% their revenue estimates; earnings growth is 27%, year-on-year, while revenue grew by nearly 9%. These results are outstanding but investors seem to have increasing doubts over next year’s earnings which are expected to grow by some 10%. European companies have also been busy reporting their quarterly results, with solid growth rates of 12% for earnings and 6% for revenue.

The stress in equity markets was not helped by the ongoing sagas represented by the tensions over trade, the Brexit negotiations and the Italian budget. For the first time, the European Commission formally rejected a member’s budget plans and yields on 10-year Italian bonds spiked to nearly 3.7% on the news, with the spread over Bunds climbing above 3.25%. In turn, the banking sector was under serious pressure with Italian banks being impacted the worst.

The behaviour of equity markets during October was well illustrated by the highly volatile semi conductor sector. The PHLX Semiconductor Index plunged by 17% between the 3rd and 29th of October on concerns about forward guidance, valuations and U.S. relations with China. The reaction of investors following the publication of results was brutal at times and triggered waves of selling due to the breach of key technical levels. Along with the global equity markets, the sector has started to rebound from its end October low, with a 10% upside move at the time of writing.

Investment strategy

We consider the October sell off to have been more of a temporary setback than the beginning of a new bearish trend for equity markets. When we look at monetary and economic factors, market sentiment, valuations and earnings growth prospects, we do not feel it is the time to reduce our equity exposure. Investors may have become too accustomed to levels of volatility well below long-term averages and tend to overreact when markets correct. Valuations look attractive, with European equities trading back to 2013 levels (less than 13 times next twelve month earnings), and U.S. ones (15.7x NTM) dropping below the one standard deviation from their 5-year average. The contraction of these multiples this year has been significant and tends to indicate a good entry point. We expect the equity markets to benefit from the removal of a certain number of uncertainties in the near future and to end the year on a stronger note.

Our exposure towards the U.S. dollar has not changed as we continue to believe that a lot of positive news is already priced in. The market positioning is also quite long, hence the limited potential for further massive inflows. Once again, the resolution of certain issues in Europe should contribute to boost the value of the euro versus the dollar.

THE RECENT MARKET SELL OFF IS LIKELY TO BE A TEMPORARY SETBACK

Portfolio Activity/ News

October was a stressful month for the portfolios with the equity sell off obviously being the main culprit for the monthly drawdown. All equity funds lost ground with Japanese, EM and U.S. equities faring the worst. To note that value and defensive stocks outperformed growth and cyclical ones, largely explaining a wide dispersion of our funds’returns. It was also somewhat reassuring to observe that frontier markets proved to be quite resilient as they registered less than half of the monthly loss of developed markets.

On a brighter note for the portfolios, the fixed-income and alternative exposures held up well, with the Global Macro, CTA and Risk Premia strategies even producing positive monthly contributions. It was quite revealing that major bond indices failed to record any gains during such a difficult period for risk assets; this highlights the challenge to build a truly diversified portfolio. Another positive contribution for non-USD portfolios was due to the stronger U.S. dollar which appreciated against the other major currencies.

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Newsletter | October 2018

THE SPREAD BETWEEN 10- YEAR ITALIAN DEBT AND BUNDS REACHES 3%

7.2% THE S&P 500’S BEST QUARTER SINCE 2014

 

Investment perspective 

Global equity markets ended September with modest gains following a weak start to the month. For once, Japanese equities were the outperformers while emerging market equities showed some signs of stabilisation, even if ending the month a little lower. A higher appetite for risk was reflected by the rise of the safest sovereign debt yields and a tightening of spreads for high-yield and emerging market bonds (- 38bps on the J.P. Morgan EMBI Global Spread Index). As to be expected in such a context, the Swiss franc and the Japanese yen depreciated against other major currencies.

The 3rd quarter performances of the main regional indices reflect the extent of the outperformance of U.S. equities so far this year. The S&P 500 returned 7.2%, its best quarter since the last quarter of 2013, whereas the Euro Stoxx 50 gained a marginal 0.1% and the MSCI EM lost 2%, in dollar terms. In spite of more expensive valuations, the U.S. equity market has been underpinned by an accelerating economy and the strong growth of earnings. The quarter was also notable for the fact that the broader U.S. market outperformed the mega cap tech stocks which had been leading the rally for some time.

As fully anticipated, the Federal Reserve raised its benchmark interest rate by 0.25% to 2.25% at its end-September meeting. This third hike in 2018 is widely expected to be followed by another 0.25% hike in December. The most recentcomments by the bank’s chairman, Jerome Powell, suggest that the Fed is far from ending its tightening cycle; Powell pointed to the fact that rates were “a long way from neutral at this point” and cited a “remarkably positive outlook”for the U.S. economy. These remarks have triggered even higher Treasury yields, with the 10-year Treasury yield trading at 3.2% at the time of writing.

The recent flare-up of Italian bond yields reflects investors’ concerns over the Italian budget and the much wider-than-expected deficits projected over the next years. 10-year borrowing costs have risen significantly this year, reaching their highest level since 2014. Considering the high Italian sovereign debt-to- GDP ratio, financial markets are concerned that the Italian government’splans could lead to a confrontation with the European Commission and also ultimately result into an even higher level of debt. This issue represents the biggest risk factor for European assets currently and largely explains the trend of the euro relative to other major currencies.

 

Investment strategy

During the first week of October, the financial markets have been impacted by the jump of U.S. Treasury yields in the wake of strong U.S. macro-economic data and comments from Jerome Powell, signalling a potentially more hawkish stance of the Federal Reserve. Equity markets have reacted quite negatively as they reprice the impact of higher yields on valuations. At this stage, we do not think that equities are close to losing their advantage in terms of relative valuations compared to bonds. More volatility is to be expected, but the equity asset class continues to offer a much more attractive risk/return profile. As good examples, equities listed in Japan and Europe offer price to earnings (P/E) ratios for the next twelve months of 14, a theoretical long term return of 7%, compared to a yield of 0.5% on 10-year Bunds.

As rising yields impact negatively the returns of fixed-income assets, we continue to hold an underweight sovereign debt and investment-grade bonds allocation. Our preferences for the asset class are towards senior secured loans, convertible bonds and flexible strategies with the capacity to actively manage both duration and market risks.

THE SUDDEN RISE OF SOVEREIGN YIELDS SHAKES THE MARKETS

Portfolio Activity/ News

September was a mixed month for the portfolios. The best contribution by far was provided by Japanese equities while EM equities and the trend-following CTA strategy were the worst detractors, the latter mainly due to an extended long position in interest rates. We maintain our positive outlook on Japanese equities due to a combination of attractive valuations, shareholder-friendly measures, low investor positioning and solid earnings’ growth. To a certain extent,the Japanese market also displays a lesser correlation to other developed equity markets.

In September, we took the decision to redeem a European Credit Fund because of the fund’s decreasing size of assets.This exit, for a risk management purpose, is unfortunately inopportune from an investment perspective. The strategy of the fund included the hedging of duration risk, matching our assessment that sovereign yields should continue to keep on rising gradually. At the portfolios’ level, it is however also important to point out that our overall level of duration risk across the fixed-income exposure is low.

 

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Newsletter | September 2018

THE TURKISH LIRA AND THE ARGENTINE PESO DEPRECIATED BY 25% VS. THE USD IN AUGUST

60% ARGENTINA’S LEVEL OF INTEREST RATES

Investment perspective 

August was a mixed month for global equity markets as the MSCI World Local Currency Index’s 1.1% gain was only the result of higher U.S. equity prices; in contrast, the Euro Stoxx 50 Index lost 3.8%, the Topix 1% and the MSCI EM Index 2.9%, in dollar terms, due to concerns about the ongoing trade dispute and the stress in emerging markets. This higher aversion to risk was also reflected by the significant strength of the Swiss franc, which appreciated by 2.9% against the euro, and by lower yields on U.S. Treasuries and Bunds. Emerging market bonds were badly impacted by EM currency weakness, with the J.P. Morgan EMBI Global Spread Index widening by 46bps to 400bps.

U.S. equities have continued to outperform and appear to be living in a world of their own. They are so far proving to be largely immune from the threat of a commercial war between the United States and its main trading partners and are benefiting from the acceleration of the domestic economy’s growth. The reporting of the second quarter’s corporate earnings has been outstanding, with revenue and earnings growing significantly and above analysts’ expectations. Growth stocks remain the drivers of U.S. equity performance with the technology sector and small caps leading the rally.

Turkey and Argentina continue to make negative headlines as they try to regain the confidence of financial markets. Despite their differences, both countries have seen inflation spiral out of control and investors question the independence of their central banks. Argentina has attempted to support its currency by dipping into its reserves, by seeking financial help from the IMF and by raising interest rates up to 60%, but to no avail so far. Turkey has taken a different route by not raising rates and by blaming external forces for their current plight, obviously not a response likely to reassure investors.

The chart shows that the ongoing depreciation of emerging market currencies accelerated during August with the J.P. Morgan EM Currency Index dropping by more than 6%. Since its mid-February peak, the index has lost over 16%, led by the collapse of the Turkish lira and the Argentine peso. Since the end of 2017, the peso has depreciated by 50% vs. the U.S. dollar and the lira by 42%. Other currencies hurt by heavy losses include the Brazilian real (-18%), the South African rand (-16%) and the Russian ruble (- 15%). While all emerging markets assets have seen their values drop, the currencies have suffered the most due to the unwinding of an early-year overweight positioning.

Investment strategy

The ongoing turbulence in emerging markets is weighing on market sentiment, especially as the risks of contagion are increasingly mentioned, even if not justified. Tensions over trade persist, despite the recent agreement between the U.S. and Mexico, and there has been no progress between the United States and China or Europe. This means that the tug- of-war between a strong economic and corporate framework and negative headline news is back. We are sticking to our positioning and are keeping a modest overweight allocation into equities as we believe that the supportive fundamentals will prevail, helping markets that have underperformed to make up some lost ground.

2018 is proving to be a very challenging year for portfolios, with rising U.S. yields, wider credit spreads and weak equity markets outside of the U.S. It is therefore reassuring to note that our active fund managers have fared very well relative to their benchmarks. The debate over active and passive management is ongoing, and far from concluded, but we are convinced that the selection of good active managers truly adds a lot of value to the portfolios.

THE DOLLAR EXPOSURE HAS BEEN REDUCED

Portfolio Activity/ News

August was a positive month for the portfolios. The best contributions by far were provided by U.S. equity funds, while convertible bonds and the CTA strategy contributed more modestly. Our recent recommendation to invest into a U.S. small cap growth fund has proved to be very timely as the fund produced a very strong return during the past month. Emerging and frontier markets were the worst detractors along with a Global Macro fund. For portfolios denominated in euros, the appreciation of the dollar also boosted their performance.

In August, our main investment decision was to reduce our exposure to the dollar following its steep appreciation early in the month. We believe that a lot of good news has already been priced into the greenback and observed that market positioning had become extended. We also added a new Japanese fund focused on companies with high growth potential as well as a European fund currently positioned in a defensive manner and exposed to out of favour sectors.

 

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