March 2022

“The man who lies to himself and listens to his own lies comes to a point that he cannot distinguish the truth within him, or around him, and so loses all respect for himself and for others.” Dostoevsky, The Brothers Karamazov

The month of March was dominated by the continuing war in Ukraine and its ongoing geopolitical and economic impact.  In response, a wave of sanctions was initiated in a broad and coordinated fashion that aimed to isolate the Russian government and economy but also had implications for the Europe.  While current Russian oil and gas supplies were exempted, concern for the future of supplies sparked further volatility in commodity prices.  The nickel market faced a massive disruption early in the month as a short squeeze drove a rapid 100% price move and exchange mayhem, and ripple effects are still being felt.  Volatility remained high in other asset classes as well, as rumours of ceasefires fuelled rallies which were subsequently thwarted when the rumours proved to be false.  As the month wore on markets seemed to take war news in stride and so pre-invasion trends were reasserted.  The SPX rallied to recover 3.5% of its earlier losses while both 10-year UST’s and Bunds backed up by .40%-.50% as yield curves flattened.  As expected, the Fed raised rates by .25% and indicated further, possibly faster rate hikes ahead as inflation stayed at 40-year highs in most countries.

In European markets there was little concrete follow up to February news that the ECB would start raising rates this year, and financial equities remained volatile closing 3.5% lower after having been briefly down over 15% at one stage.  The volatility was mirrored in credit markets, with yields ending the month higher but well off from mid-month levels.  Looking beyond the Ukrainian situation – and it is difficult to imagine there won’t be lasting economic ramifications – it seems very likely that we will see a formal end to negative official rates in Europe before the end of the year.  Of course, this doesn’t change the view that the ECB (like the Fed and other CBs) is quite far behind the curve and the willingness to tolerate negative real rates indicates that there is still a certain amount of “monetary policy by hoping & wishing” being executed.  At what stage this approach clashes with reality remains to be seen but given how late we are in an economic cycle that has had record amounts of stimulus, it may not take very many hikes to upset the apple cart.

Against this challenging backdrop the fund’s A shares gained 0.38% as we took advantage of the volatility to adjust the portfolio and added back some equities from names with resilient business models and little to no exposure to the Russia-Ukraine conflict. After the credit sell-off, we also added some short-to-medium duration second-tier Tier 2s from issuers with strong fundamentals which lagged the bounce by more generic names. Equities contributed +83bps in gross return with two of our core longs in banking and insurance contributing most of the performance, while credit remained pressured and contributed a negative -42bps.  Looking forward we continue to maintain a flexible approach to managing the fund.  We believe that in the near term there is still excess risk premium in parts of the credit market while equities have repriced higher rates out of expectations, and we expect to capture the rerating that will take place in both asset classes.