MBAER Bank - The Swiss Merchant Bank

The Bank with a Soul

In a festive mood: how we got inflation, central banks and factor investing right

In 2021, we launched the Global Investment Opportunities (GIO) strategies based on our proprietary factor investing approach. Our strategic asset allocation based on the insightful prediction of a surge in inflation resulted in strong risk-adjusted and relative performance for 2022.

In February 2021, we made a case for a surge in inflation, based on economic models that included governments and central banks' response to the Covid-19 crisis, as well as the bottlenecks in production created by supply-chain disruptions. We reasoned that, as total spending would go up in 2021, the output would not grow much over the same period and therefore persistently high inflation would arise.

We held our view against markets' and central banks' forecasts in 2022, until inflation hit its highest level over four decades globally and proved us correct. A number of additional factors – including less anchored inflation expectations, labor shortages and higher commodity prices due to the war in Ukraine – led to high and broad-based inflation.

Caught by surprise, the Fed has embarked on an aggressive tightening path, hiking interest rates to the current 4.25-4.50% level and starting reducing its USD 9 trillion balance sheet. The ECB raised interest rates too, bringing its policy rate to 2.0% and announced its balance sheet will start shrinking next year. Consistently with our economic thinking, our discretionary mandates currently invest in asset classes and investment styles that outperformed in previous inflationary environments[1].

Early in 2022, we expected an inflationary environment with rising real yields and higher markets volatility. Consistently with the results of our research, we decided to avoid long-term bonds, to overweight commodities and equity factors including value, momentum, quality, and low volatility. Chart 1 shows the key exposures of the GIO balanced portfolio, reflecting our long-term views and communicating our high-conviction calls.

Chart 1: GIO balanced asset allocation, as at December 2022 (in %).

Chart 1: GIO balanced asset allocation, as at December 2022 (in %). Source: SFI Public Discussion Note (2022), "Rising Inflation—A Roadmap for Investors", SFI Prof. Francesco Franzoni and Dr. Francesco Mandalà.

2022 Performance Review

Overall, our macro scenarios and asset allocation decisions proved correct, and our portfolios registered a strong risk-adjusted and relative performance vs. peers. Since the beginning of the year, as of December 18th, the GIO balanced mandate in EUR returned -7.7%, ahead of the Morningstar peer group, which returned -12.7% over the same period. Since January 2021, the performance of the GIO balanced mandate in EUR is +2.2%, well ahead of the Morningstar peer group, which returned -4.8% over the same period (see Chart 2).

Chart 2: GIO balanced mandate in EUR vs peers (net, in %).

Chart 2: GIO balanced mandate in EUR vs peers (net, in %). Source: Morningstar, mBaer calculations. MBaer's GIO performance computed across a sample of accounts in EUR. Performance shown for illustrative purposes only.

2023 Macro and Markets Outlook

We expect a significant slowdown of the global economy (world GDP growth at 2%) and persistently high inflation (world CPI at 7%). In the US, our baseline scenario is for a recession and above-consensus inflation (US CPI at 5%). The Fed will hike rates up to 6% and its balance sheet will continue shrinking. Fiscal policy measures will be limited.

In the Euro area, we expect a recession and above-consensus inflation (EA CPI at 9%). The ECB will continue hiking, an the key rate will reach 4.0% by end-2023. The ECB’s balance sheet reduction starting in early 2023 will continue through the year.

We remain positioned defensively: core allocation are value and low volatility factors, overweight cash and short duration bonds, overweight commodities and selected macro trades.

This past turbulent yea for markets reminded us of the importance of the three tenets of our investment philosophy: planning, perseverance and diversification, which will continue to guide us as we enter 2023.

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