A look at our performance over the year
In 2018, Carmignac Patrimoine (A EUR Acc units – Accumulation – ISIN FR0010135103) recorded a disappointing negative performance (-11.29% compared with -0.07% for its reference indicator*). At the beginning of the year, we expected a stabilization of global growth as Central Banks finally entered the stage of normalising monetary policy. Against that backdrop, we maintained a constructive outlook on equities, although our sectoral and geographic allocation remained highly selective and we kept a close watch on sources of market vulnerability like global growth levelling off, high investor confidence, technical fragility, and valuations.
Over the summer, as the business cycle was showing first signs of slowdown and political uncertainties kept rising, we stepped up our exposure to high-quality stocks and shied away from those in sectors that are highly vulnerable to the shifts under way. Concurrently, we have been derisking our fixed income portfolio.
In the 4th quarter, the extreme polarization of equity markets between US stocks, notably via the Tech segment, and the rest of the world hit its limits, and the US market finally corrected heavily, bringing other world equity markets further down indiscriminately. After a very strong performance since the beginning of the year, both tech and healthcare stocks have suffered from profit taking in this risk adverse environment. Despite profit taking on high multiple growth names (like Amazon) and a move towards lower multiple growth stocks, our equity portfolio suffered. Additionally, the sharp drop in oil prices impacted our energy holdings.
The main contributors and detractors
Our selection of “high visibility” names in the tech and consumer discretionary sectors was supported by expectations of a lower global economic growth. Amazon, Hermès, and Wayfair, the online store for home furniture, décor and other items, were among the top contributors.
Currency management & Equity derivatives
The US dollar appreciation which began in early April weighed on the Fund’s relative performance, given its bias towards the Euro, the Fund’s reference currency. Though we did anticipate an economic slowdown, it didn’t originate in the United States as it usually does. Hence, a resilient US economy, combined with a worsening business climate in Europe and Japan, was what drove up the greenback.
Our strategies aimed at lowering the Fund’s volatility in a context of elevated market uncertainties, notably our short positions on US technology indices, cost us.
Emerging markets investments
Both equity and fixed income were hurt by shrinking liquidity, a higher dollar and a steady stream of trade-war rhetoric. As a result, our stock portfolio in Argentina, where part of our investment case rested on strong political will to cut back government spending, and our Brazilian sovereign debt holdings weakened our performance. Our Chinese portfolio, composed primarily of domestic names operating in the country’s new economy, was likewise impacted by indiscriminate selling in the Chinese market in response to the threat of trade war.
Europe’s bond markets
The slide in 10-year German yields from 0.8% in February to 0.5% in April led us to short them once again by means of derivatives contracts. At the same time, we remained long specific sovereign bonds from the Eurozone periphery, particularly from Italy. However, the country’s political crisis triggered an unprecedented bond market correction in mid-May, while the safe-haven status of Germany’s debt drove German yields sharply downwards. That high volatility in Europe’s bond markets proved detrimental to our portfolio.
Analysis of the current environment
The collision between a change in liquidity regime & slowdown in growth will keep on producing its effects.
Compared to 2018, 2019’s situation remains unchanged: a collision between a change in the liquidity regime and a slowdown in global growth is putting very high pressure on equity markets, the brunt of which is likely to be suffered by leveraged and cyclical stocks. High-visibility growth sectors should resume their relative outperformance, although absolute returns should be much more challenged than in the past years, especially because as liquidity support decreases, the valuation factor becomes more and more discriminating. In this environment, the shift in supply and demand for government bonds should also put upward pressure on core rates. However, in periods of higher risk aversion, the best quality issuers will also act as refuge assets.
Our Global Investment Strategy
Overweight high visibility stocks, fixed income “barbell” strategy combined with active management of modified duration.
The polarisation of performances, following the reset that we have been experiencing since the end of 2018, should remain the name of the game. Indeed, we believe the weaker companies and the weaker countries will become even weaker, whereas the stronger ones will basically get the benefit of all the flows. As a result, valuations should be supported by quality. Anticipating this backdrop, we focused on quality stocks, mainly in the United States given their long-term profit-making capacity fairly uncoupled from the business cycle, and shied away from the most vulnerable sectors (i.e. cyclical leveraged sectors). We have also a reduced exposure to emerging markets, victims of the USD liquidity drain and trade tensions and kept only a small exposure to European equity markets. On the fixed income side, the Fund has a high allocation to cash and money market instruments counterbalanced by a higher risk budget on non-core European sovereign bonds and selective allocation to special credit situations and emerging market debt, CLOs (collateralized loan obligations) and tactical longs/shorts on core rates. This is a “barbell strategy” in that short-term maturities are held while also investing in longer duration sovereign and corporate bonds. In an illiquid fixed income environment, money market instruments and short-term investment grade corporate bonds offer a steady liquidity profile to the Fund.
Turning strategy into action
Focusing on key convictions balanced by increasing cash position and active management of exposures.
Regarding the physical portfolio, over the last months, we have been reducing the number of stocks to focus only on our highest convictions. From 63 stocks as of end of July 2018, we trimmed our portfolio down to 47 stocks as of December 2018. In the meantime, we have gradually reduced the risk of the credit book. Consequently, we have a portfolio balanced between a higher level of cash/cash-equivalents and strong convictions. This cash exposure is leaving us with greater leeway to strengthen our presence in market segments hard-hit by the triple cyclical shift mentioned above.
Regarding our exposure to equity markets, given the brutality with which markets have corrected, potential technical rebounds could be expected and require an agile management of the equity exposure.
Regarding modified duration management, the evolution of the correlation between bond and equity markets and the gradual shift away from this prolonged period of central bank liquidity injections and volatility suppression call for an active management of our core rates positions, albeit through a narrower corridor.
Finally, on the currency front, we have been reinforcing our exposure to the Euro as part of overall risk reduction in the portfolio.
Profit-taking on high-multiple growth names in order to increase exposure to lower-multiple growth stocks.
Technology is a crowded space and does not have a linear performance. At the end of 2018, while the broad markets did not fall very sharply, there were strong corrections below the surface. The names that have been in great demand lately are the ones that lost the most. In an environment where economic growth falls and liquidity dries up, the premium that investors are willing to pay for stocks is distorted.
Fundamentals remain intact: the sector is global and impacting many industries, offering secular and consistently stronger growth on a relative basis. Moreover, today’s “Tech” is pretty asset-light (Internet focused names) and with business models that are extremely cash generative when they work, many of these models are based on recurring revenues like software.
However despite strong fundamentals, this sector requires monitoring really closely the risk/reward and sizing of stocks.
Consumer & Health care exposure
Investing selectively in high quality names.
We have been very selective in our quest for quality stocks outside of the tech sector. Within the consumer sector, we tend to avoid companies with low visibility on future growth, margin pressure and that could suffer from e-commerce. Consequently, we look at premium positioning/niche markets. We also look for differentiated brands as well as maintain a significant exposure to healthcare, mainly in the US.
Main Risks of the Fund Equity: The Fund may be affected by stock price variations, the scale of which is dependent on external factors, stock trading volumes or market capitalization. Interest rate: Interest rate risk results in a decline in the net asset value in the event of changes in interest rates. Credit: Credit risk is the risk that the issuer may default. Currency: Currency risk is linked to exposure to a currency other than the Fund’s valuation currency, either through direct investment or the use of forward financial instruments. The Fund presents a risk of loss of capital.
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