DFO Reflections — Q2 2022

Due to the very poor development of the first quarter, I assumed that we should see a reprieve in the second quarter. Unfortunately, that did not happen. Instead, we had to experience another round of price drawdowns in all relevant asset classes.

Interestingly, losses in the global government bond markets were also more pronounced in the second quarter than in the broadly diversified global equity markets. This is a very rare occurrence, as government bonds are primarily a po rtfolio stabiliser. Government bonds only move very strongly when there are unexpected chan- ges in price levels. This is currently the case and hasn’t been seen since the 1970s. Ongoing high inflation rates make it necessary to adjust bond prices, as bond investors want to be compensated for increased inflation risks and only want to buy bonds in the secondary market (previously issued bonds) at lower prices. (Rising prices lead to rising capital market interest rates. Rising interest rates lead to falling prices for bonds in the secondary market, as newly issued bonds carry higher interest rates. In the case of a 10-year govern- ment bond, 1 percentage point rise in interest rates leads to about 7 % price drawdown).

By now, all global central banks are busy fighting inflation and raising target rates. Even the ECB is firmly planning to raise its reference rate and bury the questionable project of negative interest rates.

Capital markets are already anticipating much of the central bank action as we have seen rising capital market rates and their impact on the economy for months (e.g. rising mortgage rates, rising refi- nancing costs for businesses). This has shifted the investor narrative

from ‚fear of recession‘ to ‚fear of inflation‘ as can be seen from interest rates for long dated government bonds. 10-year U.S. Treasu- ries have already retreated significantly from recent highs around 3.25 % as inflation rates are expected to weaken in future because of an expected recession.

Recessions are usually accompanied by a reduction in demand, which in turn leads to weakening prices. It could well be that we will soon see the peak of price increases resulting from this year’s sharp rise in interest rates.

Despite all the frustration regarding the significant accounting los- ses in our portfolios, it should now be noted that we have reached valuation levels for global equities that are very attractive by histo- rical standards and have led to good long-term results in the past (equity premiums of 7 to 10 % for broadly diversified global indices, more than 6 % equity risk premium for global quality factor indices). This is probably the reason why globally diversified equity indices are holding up relatively well, if compared to global bond markets. All popular global indices from the MSCI family have reached price levels that correspond to those ‚before Covid‘. All gains from Fe- bruary 2020 have been lost. This makes quite clear that we should already have a large part of the price correction behind us.

In global bond markets, except for the euro area, valuations have been reached that can now offer inflation compensation to long- term investors. This assumes that long-term inflation rates will not exceed 2.5 to 3 %. (Over the past 30 years, average inflation has been just below 2 % p. a.) In the euro area we can witness positive interest rates again, so that the era of negative interest rates and deposit fines is coming to an end. Nevertheless, at 0.5 to 1.5 %, German government bonds do not yet offer interest rates that would compensate for inflation. Therefo- re, we would only buy such bonds in combination with broadly diver- sified equity investments and within the framework of our FairHorizon concept.

Das Family Office PTE LTD (DFO) relies on a proven and broadly diver-
sified investment approach through specially designed FairHorizons,
which use portfolio solutions and proven investment components
while adapting to the respective investment horizon and cash flow
needs of an investor: the longer the respective investment horizon
of an investor, the higher the advised risk share (equity share) should be. Conversely, risk and strong price fluctuations should be avoided if short-term investment horizons are in scope, and cash levels need to be kept high.

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