With 2021 now behind us, we take some time to reflect on another year, filled with both macro and micro developments that proved decisive in enabling investment returns for the Sturdza Family Fund, and financial markets in general. More importantly, we look to draw on lessons learned from a tumultuous few years and explore what the current setup implies going forward.
As our investors know, the year saw a number of existing dynamics persist as the economy and financial markets remain impacted today; first and foremost, by the COVID virus and its ramifications.
Even as they evolve, the extraordinary disruptions brought about by this pandemic continue to dictate to a large degree, the opportunities and risks in our societies and economies. The scale of digital adoption remains a key source of development across sectors and geographies, but the physical restraints impacting employment (travel, restaurants, entertainment, etc) and complex supply chains persist.
Financial markets, while directly connected to the realities of economic fundamentals, also react to, and anticipate specific cues, including the supply/demand of money and its price, i.e. interest rates and central bank policy.
This is another situation where 2021 is largely a continuation of the 2020 COVID outbreak. Extraordinary injections of liquidity by central banks and historical support from governments’ stimulus programs remain a dominant force for the pricing of all assets, from rates to equities, but also likely from cryptocurrencies, fine wine and SPACs to non-fungible tokens.
In a noteworthy iteration of these “hot money” flows catalysed by liquidity and risk appetite, the first month of 2021 saw investors pile all kinds of assets, including so-called “meme-stocks” such as GameStop and AMC among others, with leveraged retail money and derivatives pushing valuations of fundamentally unsound companies to massive market-to-market gains – by design no less, as hoards of seemingly disparate investors coalesced around heavily shorted positions to elicit a pop, a dynamic never seen before on such scale.
While this rare speculative behaviour had abated by February due to the sharp rotation from growth to more value stocks that took hold thanks to a normalising COVID outlook, it remained intermittently present throughout the year, as witnessed by exceptional volatility in a number of “concept assets”. With all markets supported by such powerful liquidity and speculative behaviour against an economic backdrop of disruption and unemployment, the debate around modern capitalism’s role in wealth inequality roared back to the fore.
The debate then took an unexpected turn during the summer with China’s pivot towards a “common prosperity” policy, likely aimed at curbing the outsized economic power engendered by the “winner take all” tendencies of technology platforms. The stress on technology equities in China has since remained largely unabated and continues to cast a long shadow over the significant long-term growth investment opportunities that the country has to offer, due in large part to how difficult it is to predict the exact intentions of its powerful government.
Further, the more recent developments coming from the Real Estate sector and the implications of these for China’s growth engine complicate the picture even more in our view and has weighed on both sentiment and Chinese indices.
Against the backdrop of a resurgent wave of COVID, the Federal Reserve’s December “hawkish pivot” announcing an accelerated taper and opening the door to three rate hikes, brought uneasiness across equity markets still debating the persistence of current inflationary pressures and their implications for the Fed. Whilst a normalising monetary policy is certainly called for given the stabilisation of financial markets post-March 2020, few question the significance of constant liquidity injections in supporting risk assets across the world.
In this regard, a quicker normalisation and the attitude to higher rates is likely to challenge one of the key pillars of the current market dynamic. Let us keep in perspective that according to Goldman Sachs, flows into global equity funds have surpassed $1t in 2021, exceeding the combined totals of the past 19 years, putting a number on the now-infamous “TINA” effect – “There Is No Alternative”.
Could some of these flows reverse should rates actually increase? We believe some of these adjustments have already been at work, particularly in the fourth quarter, as significant dispersion within equities has materialised, with nothing short of perfection being tolerated by investors with their fingers on the sell trigger.
Many high flyers – and sometimes completely conventional companies – suffered double-digit losses in a single day after announcing quarterly results marginally below expectations, or even worse, adopting a cautious view of 2022.
Once more, investors are reminded of how important initial conditions are, i.e. expectations, and companies such as Adobe, Paypal, or Docusign did indeed suffer from high expectations and valuations prior to announcing their respective results. That said, the current level of divergence within indices is striking again this year, particularly as broad indices, handsomely dominated by the tech mega-caps (Apple, Microsoft, Amazon, Alphabet, Meta, Tesla, Nvidia), remain strong.
For a simple illustration, one only needs to consider the difference between an equally-weighted MSCI World Index and its more traditional, market-capitalisation-weighted peer: after years of domination by the mega-caps, 2021 is no exception.
The Sturdza Family Fund navigated this challenging year rather well. Our view that longer-term interest rates and inflation expectations had reached an inflection point in early 2021 was proven half-correct as an initial spike in rates was followed by a relaxation and a flattening curve.
This said, our decision to cut duration significantly was a key catalyst in protecting our fixed-income books’ value, and importantly, facilitating diversification throughout the year.
Our belief that a rising interest rate environment might pressure equities also emboldens us in this regard. Given the implications for portfolio construction – should inflation become a risk factor, Treasuries and Equities could become correlated, a position we wish to avoid.
For now, our views remain largely unchanged, although the longer-end of the treasury curve is both technically anchored by the Fed, and subject to a potential inversion. Should the pivot be seen as too aggressive, à la 2018, it might become of interest once again in the future.
On the equities side, the Fund continued to invest with discipline while looking to take advantage of episodic volatility to initiate new positions such as Domino’s Pizza, Nemetschek (sold since), Synopsis, STMicroelectronics, Advantest, Brunswick and Murata in Q2’s early rotation; Prosus during July’s Chinese equity drawdown; Amazon and Anthem following drops in August; Willis Towers Watson after the abandoned takeover by Aon; Air Products (sold since) and International Flavors & Fragrances during the October volatility, and AllFunds and Fidelity National more recently.
We also continued to successfully utilise our derivatives strategy to collect premia on attractive companies, existing and new, that we wish to own more of at lower prices during peaks of volatility. For example: on Baidu following the Archegos saga; Docusign and Paypal after their respective Q3 earnings misses; and ASML; Pool Corp.; Disney; Sherwin Williams and Salesforce.com at various times during the year, among others.
While our generally equal-weighted portfolio construction did put us at a relative disadvantage against benchmarks, fuelled by the mega-caps’ large weightings, we were still able to navigate relatively close to indices in total returns. Most importantly given our investment philosophy, we are more than satisfied with the end results, with many of our companies delivering stellar fundamental performances and being rightly rewarded for it by the market.
Microsoft, even at a much lower average weight than in the index, was a top contributor to the Fund in absolute terms, followed by Blackstone, Alphabet, Centene, HCA, Iqvia, UnitedHealth, Autozone, Aon and O’Reilly. On the other side of the ledger, some of our payment stocks were the greatest detractors (Worldline, Global Payments), followed by Alibaba, Nitori, Activision, Iberdrola, Medtronic, Shiseido and Unilever (sold since).
However, with very few exceptions, we believe this year’s underperformers are now providing a strong setup for returns over the coming year as some of their specific headwinds dissipate. Most notably for the payment businesses, any improvement in international travel will help, while the resilience of their existing businesses should support a gradual re-rating against a now very low bar.
Over the year, we have generally maintained a steady allocation to equities, in the 60-65% range, seeing the ongoing phase of the business cycle as a fundamental support for equity markets and quality companies. For 2022, as described above, we believe in the potential for more volatility as a trend of normalisation affects both monetary policy and GDP growth – particularly if China’s current slowdown proves harder to resolve and Mr Biden’s massive “build back better” plan remains in limbo.
Valuations continue to remain somewhat elevated, or at the very least indicative of robust expectations and low-interest rates. Though many companies will surely deliver, the mood of “Mr Market” could quite easily become more volatile and offer investment opportunities for those in a position to transact.
To be clear, at the time of writing we remain broadly constructive for the potential of the equity asset class for 2022, particularly when accounting for how the market is able to adjust to known challenges, and arguably, all of the above are already widely understood.
Focusing on the opportunities, we believe the upside risks could potentially be significant, especially if Omicron proves more benign or additional progress is made on the COVID prevention front.
Further, a key source of upside could come from China. Increased stimulus towards a Capex cycle, which has been lacking for many years in developed markets, maybe spurred by a soft landing of the Real Estate sector, counteracting the US monetary policy headwind; or the more profound trends, such as near-shoring and the need to resolve logistical challenges.
Against this backdrop, the expectation for more volatility and weaker decorrelation potential from the fixed-income book, the Fund has slightly decreased its overall equity exposure to just below 60%. We constantly remain on the lookout for more investment opportunities and believe 2022 will continue to provide us with positive returns.
While it is paramount for us to warn against extrapolating the past 3 years into the future, we will continue to explore all avenues vigorously in order to generate sound long-term returns, based on a combination of fundamental performance by companies held in the equity portfolio, opportune asset allocation decisions and return-generating and complementary management of our fixed-income portfolio.
As always, we invite investors and prospective investors, to contact us should they wish to understand our views on the current situation and the positions held in the portfolio. Please do not hesitate to contact us for further information.
+44 1481 742380
The views and statements contained herein are those of Banque Eric Sturdza SA in their capacity as Investment Advisers to the Fund as of 16/12/2021 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.