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The first two quarters of 2020 were breath-taking. Q1 was denominated by the outbreak of Covid-19 and the closing down of society as we know it. Q2 followed this with a large number and huge size of stimulus packages announced globally by central banks and governments. In comparison, Q3 had an earnings season that was better than feared, broadly positive equity markets and a macroeconomic bounc off of the lows seen mid-lock down.
This same level of action and eventfulness was visible in the discretionary model portfolios. Q1 had the pre-Covid cleansing where positions related to travel/tourism, hospitality and retail were predominantly sold along with higher credit risk positions. Q2 witnessed the redeployment of risk into our Covid-19 strategy via our resilient and recovery baskets. In comparison, we moved through much of Q3 with minimal adjustments to our model allocations.
One thing that has become abundantly clear over the last few months is that the current interest rate environment, and therefore by definition returns environment, that we are operating in will be with us for a number of years. Accordingly, Q2 also involved adjustments in the fixed income components of the portfolio – as short dated government bond yields moved to zero (or below) and necessitated a switch into short dated but liquid investment grade bonds.
There are implications on a forward looking basis which factor into the levels of risk contained within model portfolios and potential impact on expected return. As an investment house, Dolfin has chosen to not increase the credit risk within the portfolios to try and maintain the fixed income performance contribution component at a steady level. We are minimising cash drag through holding short dated corporate bonds, but when interest rates have been cut as quickly and severely as they were earlier this year there is simply not the yield available in the market.
Fixed income strategy update
Looking deeper into the fixed income strategy, and balancing the credit risk given the weak underlying economic backdrop with the desire to generate some additional performance in the model portfolios we have allocated into a small number of individual company corporate bonds in the investment grade and high yield space. This has primarily been funded through allocations from our bond ETF holdings. In the current environment there are a number of sectors that we want to avoid, have concerns over the leverage companies are holding and specific duration that we are comfortable holding within the portfolio.
Shorter dated government bonds become almost a nonsensical holding with zero contribution to portfolio return and very limited downside protection for the shorter dated names. Longer dated government bonds still provide some downside protection and are worth continuing to hold in the portfolio, but position sizing is important given the potential contribution to portfolio volatility.
Looking into the back part of 2020 we are looking to build more allocation to individual names to further increase control of our exposure on the fixed income side.
Equity strategy update
Our equity strategy remained unchanged and untouched for much of Q3. Having added in some core equity exposure during the quarter we still remain about 50% invested on a risk assets basis.
As we continue to be happy with the single stocks we were holding, and continue to believe in the strategy behind them, we saw little reason to change anything. Performance has been strong, especially in our resilient holdings, which helped generate consistent performance without contributing excessively on the volatility side.
Our allocation to equities continues to have a heavier weighting into satellites than core given our view of the underlying market conditions. Whilst we have been reviewing the possibility of adding new core equity positions into the portfolio, these will have to be done on a very selective basis and nimbleness will continue to be key going forward.
With all nine of our global multi asset models being positive on a YTD basis, having experienced very limited downside in March and with our risk adjusted performance very strong given low annualised volatility we are happy with our performance so far in 2020. There is still time left to generate more performance although a lot of the juice has already been squeezed out of the market.
Past performance is not a reliable indicator of future returns. Forecasts are not a reliable indicator of future returns. If the information is not listed in your base currency, then the result may increase or decrease due to currency fluctuations.
If not otherwise indicated, all graphs are sourced from Dolfin research, October 2020.
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