DFO Reflections — Q4 2022

The final quarter, as well as the year, did considerable damage to
our safety building blocks. Above all, the building blocks that invest in European government and corporate bonds have suffered further paper losses because the ECB has made it clear that it is not yet finished with its interest rate hiking campaign.
This is very frustrating as safety building blocks normally stand for stability in a portfolio and are supposed to balance the highly volatile return building blocks.
2022 was clearly the year of rapid interest rate hikes, for which the financial market was not prepared. However, 2022 can also be seen as the year that ended the long-lasting, unnatural situation of nega- tive interest rates, especially for European government bonds, and brought about the return to a more normal interest rate level.
After a long wait, savers are once again receiving interest rates that are close to compensating for inflation.
This ‚re-boot‘ was very quick and abrupt, which is why we had to endure paper losses for bonds that often exceed those of broadly diversified equity indices.
The paper losses are highest for long-dated bonds, followed by medium-dated bonds and the smallest for very short-dated govern- ment bonds.
Similar developments have been very rare in history, which is why bond savers should not throw in the towel; safety components still have their rightful place in a well-designed portfolio.

Specific lessons of 2022:

  1. Bonds are also affected by volatility and price adjustments, hence should only be bought if they display valuations that compensate for inflation. For a long time, this was not the case, which is why Das Family Office repeatedly pointed out that the purchase of safety (bond) building blocks should only be made in combination with the purchase of return (equity) building blocks. A minimum of 20 to 30 % return building blocks should be considered in any case. Alternati- vely, our standard safety components ‘Portfolio 2’ and ‘Port- folio 3’ always include an equity allocation of 20 % and 40 % respectively. As global bond markets are now again offering real interest rates that can largely offset long-term inflation expectations, we consider the risk of further losses in safety building blocks to be manageable.
  2. Bond markets have seen a ‚bloodbath‘ that does not usually occur in this form and has now led to bond prices which should offer significant compensation for inflation. Therefo- re, investors should not say goodbye to their bond building blocks now. The sharp rise in interest rates will support prices.

Any paper losses should be recouped over a few quarters. In the case of building blocks containing medium- and long-term

bonds, we expect a longer recovery period, which unfortunately could last about 3-4 years.

However, the systematic nature of bond indices (bonds with low interest rates are exchanged for bonds with high interest rates at maturity) will inevitably lead to an offsetting of paper losses. From this point of view, we do not advise selling the safety com- ponents unless there’s a need for an overall strategy shift.

An important lesson for safety-oriented investors should above all be, to dare to invest money that is not needed in the long term in return building blocks with broadly diversified quality stocks. Over the last 5 and 10 years, these have performed considerably better than safety building blocks and could always beat inflation.

However, safety components with paper losses should not be sold now, as they are very likely to recover soon and still offer a good complement for return components.

Only if the selected investment horizon was too short should safety building blocks be exchanged for return building blocks!

The standard portfolio building blocks Portfolio 2 and Portfolio 3, which we have widely touted, have held up quite well compa- red to bond-only building blocks and should also recover more quickly.

Many of our clients hold these building blocks in their portfolios and can now feel like relative winners in a horrendous market environment.