THE VIEWS OF OUR PORTFOLIO MANAGERS
Strategic Europe Value Fund
The fact that China devalued its currency some days ago should not have come as a surprise to anybody as it had been clear for some time that the Yuan was overvalued and that the export sector in China was suffering. The investment environment of 2015 had been relatively benign but I think that this will be seen as the Black Swan event for 2015 in due course. China has now joined the currency competitive devaluation game and given its size will have major repercussions around the region and the world. It is clear that the Chinese slowdown is having a severe impact on economic growth in Asia and this will have implications for economic growth worldwide. The next important event will be the perceived actions of the Federal Reserve in the US – if it raises interest rates then the US dollar will strengthen substantially and this will further worsen the economic impact upon the emerging market economies. If it does not, and perhaps due to the slowdown in the economy even consider QE4, then the US dollar will weaken with negative implications for the multinationals in Europe.
We had raised the cash level in the portfolio before the recent downturn and had even bought some puts so, on a relative basis, the Fund has performed OK. We are taking a very hard look at all positions at the moment as we will take the Fund more defensive given that we do not believe that the period of volatility is over. It is going to be even more important that the companies we do hold in the portfolio can deliver on their expected growth rates.
Strategic European Smaller Companies Fund
The S&P 500 and EuroStoxx 600 have corrected for the first time in three years, declining by 11% and 14% respectively from their May record high. Lots has been written about reasons for the sell off last week and Monday this week, triggered by the sharp fall in Chinese equities, the Yuan devaluation and the disappointing July PMI report in China but much of this has been building for a while and was certainly overshadowed by the outcome of the Greek negotiations. China started rolling over in May and commodity prices had been falling for much longer. It seemed that Chinese institutions had apparently decided it became too expensive to intervene and stabilise the capital markets, contributing to the sell off in Chinese equities. The value of the market to GDP in China is approximately 25% of that of the US, so the risk of contagion to the real economy should remain limited, at least on that front. On 25 August, after the Chinese Central Bank announced that it will reduce its one-year lending rate by 25 basis points and cut the bank’s required reserve ratio, stock markets rebounded by 3-4% and emerging markets currencies that weakened drastically in the past week reversed their course.
Over the past few days, it appeared evident that the express concern for equity investors was that the China weakness and emerging markets imbalances will present impediments to US growth and European recovery. At this stage, we find it extremely difficult to come to a conclusion as to what the impact will be of an economic slowdown in China into the Western world. The Fund however had kept a 15% cash position since inception in May this year and the cash portion was increased to approximately 20% of the Fund at the end of last week. This prudence has enabled the Fund to outperform its benchmark by more than 250bps this month and more than 200 bps since inception. Emerging market indirect exposure, foreign currency fluctuation risks, already limited last week, have been reduced to a minimal amount. Even if it is not our desire to maintain a sizable portion of cash in the Fund, we shall retain that cushion in the near future to try and better exploit the marked increase in market volatility for the coming weeks/months.
Strategic US Momentum & Value Fund
The latest news out of China, namely the devaluation of the Yuan and weak PMI readings, have placed further pressure on investors and caused a correction in global equities. In the US, while the initial weakness materialised in profit taking and thus most heavily penalised companies that had outperformed in the past year, the sell off eventually expanded, with little differentiation between sectors, styles or attributes. Stabilisation will require credible signs of containment in the case of China’s economy, support from the Federal Reserve and evidence that the US economy can hum along with the consumer reaping the benefits of lower commodity prices and a strong dollar. To remain conservative in these times of volatility, the portfolio’s market exposure was reduced and cash raised to above-average levels, providing additional downside protection and dry powder. While we continue to monitor the market for opportunities, we do not intend on acting before more clarity has been obtained on the macroeconomic front. We remain comforted by our current portfolio composed of strong companies with predominantly company-specific growth drivers and track records of resilience. As these high quality companies continue to deliver bottom-line growth and trade at undemanding valuations, they should be in positions to weather this storm.
ERIC VANRAES AND PASCAL PERRONE
Strategic Euro Bond Fund & Strategic Global Bond Fund
In July and August, given the increasing probability of correction in the major equity markets due to China, Greece, the Fed and oil prices, we remained very cautious and decreased the credit risk of our portfolios. As credit spreads are highly correlated to the behaviour of stock markets, we decreased the exposure of our funds to high-beta names. At the same time, we increased the exposure to government bonds.
In the Strategic Euro Bond Fund, the portfolio strategy has been amended for (i) higher liquidity, (ii) higher credit quality, (iii) lower correlation to stock markets and (iv) lower exposure to Asia. We bought Eurozone Sovereign bonds (7% of the assets) and Public Sector Purchasing Program (PSPP) bonds (7.5% government-owned corporates included in the QE purchasing list of the ECB.) We also bought Government-owned corporates which we believe are not yet included in the PSPP (18.9%). Today, 14.5% of the Fund is invested in bonds bought by the ECB and if, in the coming weeks, the PSPP is extended, this could reach 33.3%. At the same time, we decreased sharply our BBB corporate exposure to 3.5%. Finally, we decreased our exposure to Asia from 12.8% (as of June 30) to 3.6% today as the weight of South Korea dropped from 9.7% to 1.1%. The modified duration of the Fund reaches 2.5 today, close to the maximum of 3.
In the Strategic Global Bond Fund, we added some US Treasury 2045 as duration (above 5) and a substantial exposure to 30y treasuries (above 10% of the portfolio but above 35% of the duration risk) are the most efficient investment in line with our current strategy. We also decreased the weight of BBB corporates (Pernod Ricard, Bimbo, GM, Ford and Autozone) in favour of European PSPP names (BNG and Enel) even if these bonds denominated in USD will not be purchased by the ECB, (we believe their spread will tighten in line with the rally of EUR denominated bonds.) The current modified duration is 5.5 and more than ever, we believe that the flattening of the US Treasury curve (with 5-30y rallying from 150 to 100bps, currently 132 bps) is the key driver of future performance.
The major issue in the fixed-income markets is liquidity. We have the conviction that high yield will suffer and that BBB credit spreads could widen significantly. In the coming weeks, we will continue to favour duration, high quality and, first and foremost, high liquidity. Given this positioning, we are confident that both Funds are a natural hedge against stock markets correction and increased volatility, even if at this stage, we are still confident that Central Banks will take measures to prevent any big accident in the stock markets, “whatever it takes”…
Strategic China Panda Fund
The unexpected RMB devaluation triggered this round of market sell-off. Competitive currency devaluation followed by emerging markets are raising concerns that this is a remake of 1997 Asian crisis. We caution however that the financial strength of ASEAN countries today is in much better shape than it was back in 1997 and hence a repeat of the 1997 style Asian crisis is unlikely. If there is no financial crisis, the market is certainly undershooting to the downside as per low market valuation (MSCI China PER at 8.9x). The MSCI China index and Shanghai Composite have been down 15% and 27% respectively since the recent RMB move. This has priced in more than 10% RMB devaluation already. We see a relief rally if no systematic risk unfolds in the following weeks.
Stock level wise, even companies with good fundamentals are also under selling pressure as the sell off so far has been quite indiscriminate. However, we definitely see value emerging. With more easing from the government, we expect macro to eventually stabilise. In short, the market moves are suggesting a financial crisis in the making but we see no crisis. We are holding 11% cash in the portfolio and look to redeploy the cash as the dust settles.
Nippon Growth (UCITS) Fund
We believe that China has many options from here to stimulate the real economy as well as the market.
It is important for the market to believe in the growth of the actual economy and not just the stock price. In that case we think that both market stimulus as well as fiscal policy are a necessity. We believe that China will announce government spending within a month, which can stimulate the actual economic activities and, of course, China has more room to cut the interest rate.
Currently there is an outstanding balance of more than 1.3 trillion Yuan margin trading transactions in the Chinese market which remain to be resolved. It will take time to ease the issue but we believe that it is durable and that the Chinese market can regain stability in September.
In the meantime, we are steadily witnessing economic recovery in Japan. Once the Upper House passes security-related bills, Prime Minister Abe is expected to re-focus on the economy and Japanese stocks will become more solid. We consider that 125 Yen/USD is too high and that the JPY is likely to depreciate albeit slowly towards 120 or 115 per USD and that this level is competitive enough for Japanese manufacturing and also helpful for the importers.
From mid-September, we expect the Japanese market to regain confidence and that economic sensitive stocks such as Banking and Real Estate should perform. Our portfolio is prepared for another rally and we have no intention of changing this as of today.
The views and statements contained herein are those of the Investment Advisers to the respective Funds as of 25 August 2015.