It has been a challenging period so far for both equities and bonds in 2022. The era of loose monetary policy is over as inflation races around the world, leaving policymakers with no choice but to raise interest rates and scale back bond buying programmes.
Central bankers are determined and have made fighting inflation their priority even if, in the process, the likelihood of recession increases. With aggressive interest rate hikes, they are trying to push down inflation expectations and, in doing so, they seem to care little about financial markets. Investors have been warned.
Equities and bonds moving down together
Mixed funds have suffered significant pain so far this year as the correlation between equities and bonds has turned positive since 2021. This has led to heavy losses on both the equity and bond sides of these portfolios.
In doing so, it is interesting to note that funds suffered somewhat similar losses at all risk levels. Defensive mix funds in the euro cautious allocation - a global Morningstar category - lost 8.5 percent on average compared to 10 and 10.8 percent for the neutral and offensive equivalents, respectively.
Presumably, the latter came as a surprise to many investors as they would rather expect mix funds with a lower exposure to equities, and a higher exposure to fixed income, to actually mitigate losses during market turmoil as was the case during the wave of selling in the first quarter of 2020. Indeed, during that period, the differences were much larger with an 8.1 percent loss for funds in the defensive category and 12.2 and 16.3 percentage point corrections for the neutral and aggressive allocation funds, respectively.
Managers reduced durations
In the current year to the end of August, the Morningstar Euro Cautious Global Target Allocation index lost 9.9 percent itself, more than the eponymous neutral (-9 percent) and aggressive (-8.4 percent) allocation index. The difference with the category averages - where the proportions are thus reversed - is largely explained by the fact that many active managers anticipated interest rate rises last year and had reduced their durations. Today, the average defensive allocation fund is overweight the index in the shorter maturities. This overall preference is favourable in periods when government bonds correct sharply.
Headwinds for growth equities
Active managers could further differentiate themselves by favouring value over growth equities or by taking positions in the dollar or commodities. A good example of a mix fund that managed to get through this year without much adversity is DWS Concept Kaldemorgen. The fund lost just 1.6 percent so far this year after Klaus Kaldemorgen reduced exposure to growth and cyclical stocks and expanded positions in defensive equities. Gold and a preference for the dollar as well as low duration helped the strategy further in the first eight months of this year. This fund is part of the EUR flexible allocation - global Morningstar category and was therefore not included in this week’s top 5 list below.
Morningstar Euro Global Target Allocation Indexes’ Performance:
Source: Morningstar Direct. Data as of 31 Augustus 2022
Top 5
For this week’s Top 5, we look at mutual funds in the Morningstar Categories EUR Cautious Allocation (- Global) whose distribution fee-free fund class is available in the Netherlands and Belgium. These five funds have shown the best performance based on returns over the first eight months of 2022.
Fidelity SMART Global Defensive Fund
Fidelity SMART Global Defensive Fund is in the lead with a year-to-date return of 0.8 percent for the Y Acc EUR fund class. This fund allocates between different asset classes based on volatility. It aims for a volatility of 2-5 percent per year, using a proprietary quantitative model. In addition, portfolio managers Eugene Philalithis and Rahul Srivatsa seek to add value by investing in strategies designed to perform well in both upside and downside markets. Philalithis is no stranger to Morningstar analysts who rate him and his team positively on the Multi Asset Income strategy with a “Bronze” rating. Rahul Srivatsa focuses on quantitative analysis and research in addition to portfolio management.
The fund may invest up to 40 percent in equities and up to 100 percent in government, corporate, inflation-linked and emerging market bonds. Up to 40 percent can be invested in high yield bonds and 10 percent in hybrid debt securities such as convertible securities. As of end-May 2022, only 6.2 percent of all assets were invested in equities while inflation-protected bonds on the one hand and government bonds and related derivatives on the other both took up a third of the portfolio. Just under 10 percent was invested in internal but mostly external funds and ETFs. The fund alternates strong years with lesser periods, but finished in the first decile of its EUR cautious allocation - global Morningstar category over the last five and 10 years as of the end of August 2022.
AXA World Funds - Global Income Generation
AXA World Funds - Global Income Generation stranded in second place in our list and has been managed by Andrew Etherington and Frédérique Maherault since 2015. Etherington has been working for AXA for almost 10 years and previously worked at Natixis until 2012. Maherault is a bond specialist who became a portfolio manager at AXA in 1999. Both managers are based in Paris.
Unlike Fidelity, this fund had almost 29 percent of its assets in equities as of end-August 2022. The equity portion consisted mainly of large cap value stocks with considerations towards the financial and health sectors as well as real estate and basic materials. It was underweight in the technology sector. Within the bond section, we see that 23 percent of the portfolio is made up of investment grade corporate bonds and 26 percent of emerging and high yield bonds. The fund is clearly underweight in government bonds and has an average credit rating of BBB- and a modified duration of 3.2.
Top 5 defensive mix funds, as per NL share class:
Top 5 defensive mix funds, as per BE share class:
Thomas De Fauw is a manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds on the basis of quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.
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