“Avoid the extremes of the market: deep value stocks and expensive growth stocks. It is in the latter segment that the greatest danger lies, given the strong dominance of retail investors. Cathie Wood with its ARK ETFs is a perfect example of this. Good risk management is important in all areas of fund management. And, of course, sustainability criteria are crucial.”
These are some of the views of Christian Schmitt, manager of the Ethna-Dynamisch fund of the Luxembourg investment company Ethenea, in an interview with Investment Officer.
Strategic versus tactical
Schmitt approaches management from two angles. “From a strategic point of view, equities are in great shape,” he said. “Which has actually been the case for years thanks to low interest rates.”
“Central banks are injecting massive amounts of liquidity and the economy is doing very well thanks to this stimulus,” he explained. “On the tactical side, we’re wondering what investors’ current expectations are and how they’ve positioned themselves in that regard.”
On the latter point, he sees a big difference between retail and institutional investors today.
“Retail investors are clearly in a euphoric phase, especially in the US” he said. “They are mainly focused on highly speculative segments of the market, such as SPACs, crypto-currencies, hydrogen, biotech, etc.”
Institutional investors, on the other hand, are not as euphoric, according to Schmitt, “although they are positive on equities because of favourable environmental factors.” He sees the over-optimism of retail investors as a big risk, explaining that most institutional investors are far from fully invested in equities. “So there is obvious bullish potential if this group of investors also enters a euphoric phase,” he said.
Today we are in the middle of the earnings season and these are generally excellent because the basis of comparison is the 2020 lockdown period. “However, most of this good news is already priced in,” Schmitt said. “We are now in the second phase of the bull market, which usually comes with greater volatility.”
“In fact,” Schmitt continued, “the markets are not going anywhere and we think that by the end of the summer, the stock market indices will be at the same level as today. ” Schmitt said he sees the downside risk as limited because liquidity is everywhere. “We think the market will go up by 20% rather than down by 20%,” he adds.
Retail investor euphoria
Today, the Ethna-Dynamisch fund has a clear focus on equities. “Currently, about 70% of the fund is in equities,” explained Schmitt. “We reduced this position with the summer in mind, as the equity position was previously 80%”. Schmitt went on to add: “In terms of sectors, we are extremely diversified and also try to avoid the extremes, such as deep value and expensive growth stocks, as that is where the greatest risks lie.”
Gold represents 5% of the Ethna-Dynamisch portfolio. “The possible return of inflation is always a concern and commodities offer additional diversification,” said Schmitt. “We also have 5% in bonds denominated in Norwegian kroner, as the Norwegian government’s finances are strong and this also gives us some exposure to the oil market.” Otherwise, the fund has no bonds in its portfolio, which Schmitt says has been the case for years now.
Regarding the value/growth debate, the Ethenea manager distinguishes between various points. “At the moment, there is talk of economic recovery, but the markets started to take this into account about a year ago.” Schmitt pointed out that cyclical stocks started to outperform defensives by a wide margin in April 2020.
“In other words, this is not new”, he said. “Moreover, we believe that most value companies are facing structural problems that they had before the pandemic, many of which are still present.”
At the same time, Schmitt believes that the euphoria in the retail sector is mainly about the growth side of the market. “The success of Cathie Woods and her ARK funds already explains a lot,” he said. “In the last few months, out of a total of some $25 billion, $10 billion has come from retail investors.” He added that: “It should be noted that most of this new money is currently at a loss.”
Schmitt explained that in addition, $25 billion is invested in similar funds (mainly copies of UCITS). “Should these ARK stocks come under pressure, because ARK funds are dominant in many of these stocks, there is a possibility of liquidation,” he said. “Here our flexibility can come in handy to find hedges through the use of options.” He added that “Today, we have already hedged if technology stocks were to fall back.”
Risk management
Schmitt explained that his firm’s mission is to enable its clients to access the financial markets with as little risk as possible. “For my fund, Ethna-Dynamisch, the latter is not an unnecessary luxury given the higher exposure to equities,” emphasises manager Christian Schmitt. “We are successful because of our flexibility and adaptability.”
The firm does not limit itself to a certain management style, does not work with restrictions and tries to adapt to all market conditions. “Thanks to our flexible structure, we can do that,” he said. He added that almost every decision taken incorporates the aspect of how to avoid risk as much as possible.
Schmitt explained that he doesn’t believe in methods that force you to automatically exit the market at some point. “These systems would have forced you to sell in March 2020, almost at the bottom of the market, like some robot managers”, he said
Schmitt explained that for his firm “it’s very important to be able to look beyond that”. He pointed out that the firm has developed risk management at the individual level, by looking for companies with strong balance sheets, good management, etc., “as well as looking at markets with a top/down approach so that we can build in safety when the risk/reward ratio is negative,” he said. “We also reduce risk by using put options.”
ESG: under regulatory pressure
Finally, the manager offered his views on ESG and its implementation. “The debate on sustainability has been going on for decades, but its implementation has always been difficult, because the consumer will not do it by himself.”
According to Schmitt, the regulator decided to implement it via the financial industry. “These are financial flows, and if you push them in a certain direction, it happens almost automatically,” he said.
He also points out that in the meantime, all ESG criteria have been introduced into the existing product range. “Before, it was all about performance, risk management and liquidity, but now ESG factors have been added.”
“We now include them in all decisions and it is up to each individual manager to integrate ESG into every level of decision,” Schmitt went on to explain. “Given the huge universe in which we invest, we cannot do all the ESG work ourselves.” He added that for the initial ESG screening, his firm works with an external agency called Sustainalytics.
He described the firm by saying “They are a big data provider and to make good decisions you need data.”
Schmitt cautions that not everything is crystal clear yet. “For performance and risk analysis, you have the necessary data, for example in the balance sheet or income statement,” he said. “But when it comes to ESG and sustainability, the data is still not uniform.”
Ethna-Dynamisch
LU0455735596
Annual return over the last five years: 4.94
Operating costs: 2
Assets under management: 229.01 million euros
Consists of a highly concentrated portfolio of 30 to 40 stocks representing more than 70% of the portfolio. According to the manager, all these companies structurally benefit from a tailwind and are correctly valued.
In his stock selection, he focuses mainly on the ‘open economy’ theme. He also holds significant positions in gold, bonds denominated in Norwegian kroner and derivatives, mainly for hedging purposes.