DFO Reflections — Q3 2022

After a strong global equity market rally in July, an equally strong correction followed in late August and throughout September, so that at the end of the third quarter we are basically back to where we saw ourselves at the end of the second quarter. This means historic losses for global government and corporate bonds, which haven’t occurred since the 1930s and 1970s, and large losses in global equities.

European government bonds in particular saw sharp price drawdowns in the quarter, because it has become clear that the ECB is also raising its reference rates sharply in order to counter stubborn inflation. This had not been communicated so clearly at the end of the second quarter, even though many signs pointed to it. In the meantime, the ECB has pushed its reference rates back above zero, consigning terms like „negative interest rates“ and „savings account deposit fees“ to the history books.

Asian issued, U.S. Dollar denominated investment grade- and high yield debt continued to under-perform in Q3. Investors can now expect additional yields between 2 to 5 % vis a vis U.S. issued Dol- lar debt, which makes it very attractive for the long term investor.

(Remember: rising prices lead to rising capital market interest rates. Rising interest rates lead to falling prices for bonds already outstanding, as newly issued bonds carry higher interest rates. In the case of a 10-year government bond, 1 percentage point rise in interest rates leads to about 7 percentage points price adjust- ment).

We had pointed out in our 2nd quarterly report that European bonds were still relatively far behind in the adjustment process compared to American and international bonds and advised against buying them.

However, after the considerable price setbacks of the third quar- ter, we can slowly see an end to the historical interest rate adjust- ment process, as investors can once again receive more than 2 % interest for European government bonds. For corporate and high yield debt, they can receive more than 4 % p. a. and 8 % p. a., respectively.

Even though current inflation rates are between 6 to 10 %, de- pending on a given country, medium-term inflation expectations (breakeven yields) are about 2 to 2.5 % p. a. Thus, bond buyers are finally compensated for inflation in the medium term and can expect positive real interest rates. Such attractive rates have not been seen for more than a decade and suggest that we are slowly approaching the end of the brutal interest rate adjustment process of 2022.

This attractive new interest rate level is a function of the massive price depreciation for medium- and long-term bonds, and little consolation for the holders of such bonds and corresponding investment building blocks. They will probably have to wait a few years until these significant accounting losses have been com- pletely offset. The good news is that compensation will inevitably take place as newly issued bonds carry higher interest rates and will gradually replace bonds with low or no interest rates in the various bond indices and bond portfolios!

For new investments, however, current valuation levels seem increasingly interesting. That said, we still prefer to buy safe investment grade bonds in combination with broadly diversified and high-quality global equity investments. This balanced strate- gy based on our FairHorizon Concept has proven itself again in this difficult year, as the balanced portfolios survived the current infla- tion crisis considerably better than pure bond portfolios.

Compared to the historical price adjustment in bond markets, the losses in global equities seem relatively ‘normal’ even though painful double-digit price declines were also recorded. Shares of global smaller quality companies have had an exceptionally bad year, which is probably a result of their high valuation at the beginning of the year. Valuations do matter!

The well-known and broadly diversified equity indices of the ‘MSCI family’ have now all fallen back to ‘pre-Covid’ levels. In other words, almost all the gains resulting from various Covid sti- mulation programmes have been lost. This fact, together with the attractive valuations of global equity and bond markets, indicates that we can slowly prepare for the end of the current bear market:

To the extent that investors can now expect inflation compen- sation when buying new bonds (positive real interest rates), new buyers of equities are also able to collect substantial risk premi- ums ranging from 7 to 10 % p. a., clearly compensating for even above-average inflation rates.

These high premiums compare very favourably with the averages of the past and encourage us to continue to recommend long-term (quality) equity investments. The much criticized 60 (Equity) and 40 (Bond) portfolio, which is often used for medium term investment strategies, should continue to do well for patient investors.

Das Family Office PTE. LTD. relies on a proven and broadly diversified investment approach through the specially designed FAIRHORIZONS, which shows portfolio solutions and proven investment components while adapting to the respective investment horizons and cash flows 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 volatility should be avoided if short-term investment horizons are in scope and cash needs to be readily available.

As an independent, client fee-based advisor, licensed by MAS (CMS licence), we focus on comprehensive investor education and do not receive any commissions or hidden fees from fund companies, banks or other product providers.

If you have not yet become aware of us, we would like to invite and encourage you to take a look at our website www.dfo.sg and reach out to us at [email protected].

With this in mind, have fun browsing through the various data and presentations of investment modules and reference portfolios. It‘s worth it!