Q4 2022

Q4 was a strong finish to a historically terrible year for most asset classes. Fixed income securities had their worst year ever, with the Bloomberg Global Aggregate Bond falling 16.3%. The model 60/40 portfolio had its second worst year on record since 1988. Investment grade and high yield bonds suffered losses of over 17% and 10% respectively. Equities fared worse; the Nasdaq Composite fell 25.1% and the S&P 500 down 19.4%. Areas such as cryptocurrency, unprofitable technology and SPACs ended the year in tatters.

The direction of economies and markets will depend heavily upon inflation and the required monetary policy required to bring it to target levels. If inflation remains elevated, it will be difficult for the demand side of the economy to sustain and easy for central banks to continue to tighten policy. If inflation eases, consumers will feel price relief and there will be less pressure for monetary policies which would trigger a recession. We are minded to believe that inflation will prove more difficult to bring down to 2% target levels and that interest rates may need to remain higher for longer than is currently priced in, not least with wages rising at 4-5% in a strong labour market. However, it is difficult to know which argument will prove correct and we think the best way to navigate this is with a flexible investment approach across different asset classes, especially in sectors and strategies where the opportunity set, and expected returns, have risen.

2022 was a decent year for our portfolios. All strategies bar equity-related strategies were positive for the year, and indeed within equity strategies we saw good performance in lower net, less directional funds. Key is that the return expectations for our strategies has risen. The increase in the risk-free rate leads to a natural increase in returns for many of these strategies, in particular certain relative value strategies, which operate with high cash balances. From earning 0% at the start of 2022, these cash balances now earn in the region of 4%. Many strategies also invest in spreads, be it relative value spreads or merger arbitrage spreads. These are short duration in nature (the event which should cause the spread to close) often occurring within 3 to 6 months, and priced off the risk-free rate. The expected return has increased commensurately; what used to be expected to return mid- to high-single digits is now high-single to low-double digits. These are less directional strategies and, in aggregate, were positive for us in 2022. This is in addition to a positive outlook for the fundamentals of our investment strategies.