Yoann Ignatiew
General Partner, Head of International Equity and Diversified
International equity markets ended the quarter in positive territory. The MSCI World All Country gained 5.6%(1), driven mainly by hopes for a shift soon in central bank policies.
While the Fed stuck with the status quo at its latest meeting, leaving its rates unchanged in a range between 5% and 5.25%, the Australian and Canadian central banks unexpectedly raised theirs, to 11- and 20-year highs, respectively. In Europe, a 25 bps hike is expected for July, which would raise key rates there to between 3.75% and 4.50%(2). While total inflation has receded significantly, core inflation has been more resilient, and the job market appears for the moment to be retaining its strength. Household and business confidence in the economic environment varies by geographical region. For example, US household confidence was surprisingly robust at 79.3, a high since January 2022. However, 69% of persons surveyed still expect a recession in the next 12 months(3). In Europe, the IFO(4) business climate index came in under expectations, in line with the latest German manufacturing PMI figure, which was far into contraction territory, at 41(5).
China had an especially heavy impact on general sentiment, with macro figures that remain mixed. Regarding domestic consumption, while travel by the general public was up by 19% compared to 2019, individual tourist expenditure fell by 10%(6). More broadly, the manufacturing PMI fell into contraction territory at 48.8. Services, while still in expansion phase at 53.9, seemed to be showing some signs of slowing in June(7). Despite a glum environment, we still think this is a good time for exposure to China. The government seems to have broken off its reforming rhetoric to focus on the country’s growth. Meanwhile, from a more micro point of view, Chinese equity valuations are especially attractive. More than mere blanket exposure to China, we are particularly positioned in its consumer stocks, as its reserve of savings is considerable. That’s why we limited our dilution during the quarter by investing marginally in stocks such as Ping An, Alibaba, Trip.com of Country Garden Services. Unemployment, particularly among young people, the global economic slowdown, persistent geopolitical tensions, and local governments’ public deficits remain major challenges for prolonging the recovery in China. Nevertheless, the resumption of dialogue with the US, the leeway allowed by non-existent inflation, and the government’s determination to support the economy are all factor making China more attractive.
During the second quarter of 2023, the tech sector was the main contributor to fund performance, thanks mainly to stocks such as Meta Platforms and Uber. Share prices of US tech megacaps soared, driven by strong inflows, as investors turned increasingly towards companies with solid earnings. Moreover, margins have improved through cost-cutting over the past few months and greater budgetary discipline. The sector has also been supported by the artificial intelligence story, with a market rewarding, somethings exuberantly so, companies positioned there. We joined the ride, with the sole exception in the sector being a marginal reduction in our Meta Platforms holding.
Industrial companies, mainly European ones, also fared very well on the quarter, even though the manufacturing PMI plunged into contraction territory. Their ability to hold onto their margins in an inflationary environment, their solid order books, and some catchingup after an especially rough 2022 all drove the sector’s rebound during the quarter. Against this backdrop, a significant portion of our reduced weightings were in stocks such as Airbus, Abb and Air Liquide. Our goal was to reduce our exposure to cyclical stocks and to take some profits on others that had performed well on the year to date. Along the same lines, we reduced our commodities exposure by selling down Teck Resources, a mining stock.
Investors’ enthusiasm for certain tech stocks has come at the expense of sectors that are more defensive, such as healthcare, which was one of the weakest contributors to fund performance on the quarter. Our exposure to the leisure and services sector also took a hit, impacted by our holding in Walt Disney, which has been challenged on its VOD profitability.
Within R-co Valor, we lowered our equity exposure to 73% in late June, along the lines of what we had been doing since late 2022. The rest of the allocation, 27%, is invested in money-market funds, French government paper maturing in less than one year, and, marginally, in cash(8).
In reaction to the gradual slowdown of economies worldwide, the unstable geopolitical environment, tougher access to credit, and the for-now-shaky recovery in China, we are sticking to our relatively conservative stance. The equity risk premium is shrinking, particularly in the US. If second quarter 2023 reporting season turns out to be of the same quality as the first quarter, equity markets could continue to move up. In this scenario, we are sticking to our profit-taking strategy by selling down our positions amidst a slowdown in the macroeconomic environment. Meanwhile, the money market looks like a suitable waiting room, with remunerations exceeding 3%(9) – which is attractive in absolute terms but also when compared to short-dated corporate bonds.
Portfolio Allocation
The fund had an equity exposure of 37% and a bond exposure of 52% as of the end of June, with the rest being invested in money-market and the cash(10).
Equity allocation
R-co Valor Balanced equity allocation replicates that of R-co Valor. Both funds have the same exposures and are subject to the same modifications.
Fixed income allocation
After a relative lull in the first half of the year, interest rates took off again on both sides of the Atlantic. Ten-year US and German yields rose, respectively, by 30 points de base (bps) to 3.8% and by 10 bps to 2.4%(7). In corporate bonds, investment grade(8) gained +0.44% on the quarter, and high yield(9) +1.84%(10). The fund gained 1.52% on the quarter. Based on an analysis by asset class, equities contributed about 60% to total performance, thanks mainly to exposure to the tech and industrial sectors. Corporate bonds played its driver role to the hilt, contributing 40% of the performance on the period(11).
After an especially rough year in 2022, the bond markets continue to offer a real opportunity. We are taking advantage of solid resiliency in high yield to gradually sell down this segment in the run-up to the refinancing problems expected for 2024-2025. We have gradually raised the fund’s sensitivity to 3,7 amidst the end soon to the cycle of rising interest rates. We are accordingly taking on exposure to the 20-year Bund and overweighting investment grade bonds, which have maturities a little longer than previously and attractive yields, such as in senior financials.
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