January 2023

“We have met the enemy and he is us.” Pogo

What a difference twelve months makes.  We entered 2023 with nary a discussion of COVID variants or restrictions outside of China, and with an aggressive cycle of interest rate hikes in the rear-view mirror.  To be sure there is still plenty of COVID-related debate in policy circles, but it is generally backward looking and more focused analysis of pandemic era decisions.  In one of the least surprising developments a number of countries are still clinging to the emergency powers they granted themselves in 2020 and the WHO is actively risking what remains of its credibility in seeking to prolong the crisis.  But the central topic for the month was clearly central banks and the future direction of monetary policy.  For now, they were content to join the huddled masses in Davos lamenting the challenges they face, albeit without the Pogo-like self-awareness.  The next step will be premature pats on the back for a job well done in engineering a soft landing.

For its part, the market wasn’t interested in what might be happening to official interest rates in the coming months and immediately started pricing an end to the tightening cycle following the release of employment data that showed signs of slowing.  The move was profound, with 10 year USTs dropping 35 bp while peripheral EUR bonds rallied even more.  And a distinctly risk on mood returned to other asset classes with the SPX bouncing 6% largely on a tech rebound.  At this point it is useful to remind ourselves that exuberant rallies are not uncommon at the end of tightening cycles and more often than not investors jump the gun only to be disappointed later.  With long term yields hovering below 3.5% there is already a lot of good news priced.  Data will be the guide from here.

Against that backdrop European financials performed well across all asset classes as excess risk premiums proved attractive to buyers.  To a certain extent this is to be expected given the start of the new year and the expected shift in central bank policy.  Of note we saw considerable interest in a number of deep value second tier securities in the fund’s portfolio with investor focus moving from the well-known larger names to second-tier credits with double-digit yields. Despite this beginning of normalization, we continue to observe large dislocations in the credit universe and see significant potential for differentiated returns in specialist names, both on the secondary and primary markets. Aside from credit, equities also responded well in anticipation of what is likely to be a very constructive earning season. For the month the fund’s A shares were up 4.9% driven by credit which contributed +487bps in gross performance, while equities added +11bps.

We began the year with a great deal of flexibility in our portfolio commitments and during the month we only moderately tweaked our holdings.  Our strategy remains the same; maintain the focus on our strongest conviction positions while retaining dry powder to deploy on the potential volatility one typically sees during transitions in monetary policy.