Market Review – 4^th quarter 2021

In the fourth quarter, developed market equities continued to rally, providing investors with the third calendar year in a row of strong positive returns. Strong earnings growth drove equities higher. Fixed income performance over the quarter was flattish, as markets had to digest rising inflation and less easy policy from central banks.

But the fear of a weaker future growth backdrop, partly due to projected central bank policy normalisation, led to a flattening of the US yield curve. Small caps also underperformed large caps over the quarter as uncertainties about future growth weighed on their performance.

In the US, President Biden signed the Infrastructure Investment and Jobs Act, a long awaited $1.2 trillion bipartisan infrastructure bill. The bill includes $550 billion of additional spending, 49% of which will be allocated to upgrading America’s transportation sector, including ports, airports, railroads, roads, bridges, and public transport, and 32% will be used to improve water and power infrastructure. The remainder will be spent on broadband (12%) and the environment (7%). The ambitious Build Back Better spending bill ($1.7 trillion) didn’t muster a majority in the Senate in December. However, private sector fundamentals look solid enough to carry US growth next year. Strong performance of financial assets and real estate have pushed the ratio of US household liabilities to assets to its lowest reading since 1973. This, along with still elevated savings, gives the consumer significant firepower in the coming years.

In Europe, an unreliable supply of Russian gas, falling investments in thermal energy and maintenance work on nuclear power plants led to a sharp rise in gas and electricity prices across the continent before falling towards the end of the quarter. Higher energy prices are adding to the rise in inflation in the region.

Inflation is also an issue outside of Europe. In December, three of the four major developed market central banks indicated that they have greater concerns about inflation heading into 2022 than about the economic disruption that could be caused by the Omicron variant. Government bond markets were mixed over the quarter. The short end of the curve moved higher in the US and the UK as markets priced in a faster pace of rate hikes.

Outlook

We made no change during the month, neither in the macro positioning, nor in the portfolio’s composition. Our equity style remains globally neutral with an overweight in small and mid-cap strategies. On the fixed income side, we are interest rate duration underweight, spread duration overweight. We are overweighted in emerging markets, both in equities and in bonds. We also have built exposure to uncorrelated fixed income strategies, such as absolute return, microfinance, and cat bonds.

The performance of the portfolios in 2021 were mixed. While the Yield and Income Portfolio slightly outperformed its benchmark (+5.0% vs. +4.9%), the Balanced Portfolio (+6.6% vs. 8.3%) and the Growth Portfolio (+6.7% vs. +11.7%) underperformed. The equity allocation and the alpha generation in equities were deteriorating which was partly offset by our fixed income exposure.

In equities, the emerging markets overweight was costly for the portfolios (-190bps for the Growth Portfolio, -80bps for the Y&I and the Balanced Portfolios). The overweight in small caps proved also to be deteriorating by -280bps for the Growth Portfolio -100bps for the Balanced and -70bps for the Y&I. Finally alpha generation in equities turned negative following the style rotation in the 4^th quarter of 2021. After many years of outperformance of growth companies, the style turnover took by surprise managers which were, with various degrees, tilted toward growth.

Absolute Return strategies had mixed contribution. Long/Short equity strategies suffered in the second half of the year from the style rotation. On the other hand, multi-assets funds performed strongly in this challenging environment. Our risk premia fund, for example, did particularly well in 2021 (+16.2%).

On the fixed income side, the short duration exposure proved to be positive at the end of the year as well as the credit overweight (Loans, Subordinated Financials and High Yield). On the other hand, emerging market debt was slightly deteriorating. Uncorrelated strategies such as cat bonds and microfinance delivered according to our expectations: steady return with no sensitivity to interest rate and spread moves. Finally, active management in fixed income contributed positively to performance.

Overall, active management (equity + fixed income) was negative (-80bps) for the Growth Portfolio, (-40bps) for the Balanced and +80bps for the Yield & Income.