Balanced ETF portfolios USD Q3 2023 commentary

Quarterly return (net of fees)

Market overview

During the third quarter of 2023, stocks and bonds posted negative returns, as investors remained concerned about the path of inflation and economic growth. Complicating the picture was higher energy costs, driven primarily by the OPEC+ decision to extend production cuts, which threatens both consumer spending and headline inflation. As inflation comes down slower than expected, investors have started pricing in a higher-for-longer interest rate environment. Against this backdrop, the Federal Reserve paused their rate hiking cycle, and the European Central Bank raised its deposit rate to a record high in September.  

Developed Market Equities broadly posted negative returns, as bearish news on economic growth, paired with the potential for rates staying higher for longer, hurt performance of the major indices. Europe outperformed the U.S., while the UK functioned as an outlier, generating positive returns for the quarter, partly due to a tilt towards the energy sector, which benefited from the rise in oil prices. 

Developed Market Sovereign Bonds experienced a substantial sell-off, reversing prior gains and marking their poorest quarterly performance in a year. 10-year U.S. Treasury and German Bunds experienced multi-year highs in yields, reflecting the market's anticipation of a prolonged period of tighter monetary policy, as well as concerns around fiscal sustainability, particularly in the US, which was downgraded over the quarter by Fitch Ratings. 

Performance within the Credit space was mixed, as investors sought opportunities to generate returns within higher-yielding assets. Consequently, High Yield bonds closed the quarter in positive territory, in contrast to Investment Grade bonds, which underperformed, delivering negative returns over the period. 

The Commodity sector witnessed robust gains and was among the top-performing asset classes during the quarter. The strong rebound in Brent Crude Oil, propelled by the OPEC+ decision to extend production cuts, paired with supply constraints in energy-related assets like Natural Gas, partly accounted for the sector's outperformance.  

Elsewhere, the U.S. Dollar appreciated during the quarter, driven by a sharp rise in real yields and increasing interest rates. Relatedly, the performance of Emerging Markets displayed a mixed picture, with certain Latin American and Middle Eastern countries benefiting from higher commodity prices and a stronger dollar, while China grappled with challenges stemming from slower-than-expected growth and concerns surrounding a potential collapse of its real estate sector.

Portfolio Allocation (05/10/2023)

Performance

The core models posted negative returns in September and Q3, underperforming their respective benchmarks. Over both the month and quarter, key developed equity exposures such as an allocation to the US weighed on returns. On a relative basis, our underweight in emerging markets supported active performance in the midst of increasing market volatility driven by concerns over China. Fixed income exposures also detracted, as long-term US Treasuries and mortgage-backed securities dragged down performance. On the other hand, exposures to floating-rate bonds and short-term US Treasuries helped.

Latest rebalance rationale

There is an increase in the portfolio’s equity exposures to overweight, from improving investor sentiment and earnings momentum. Within equities, US allocations are increased to a small overweight, as broad analyst sentiment has improved. There is a trimming of the US minimum volatility exposures and adding back to market cap tickers to align with our modestly increasing risk appetite. This also reduces the underweight to the technology sector at the portfolio level. Constructive sentiment remains on Europe on the back of strong earnings momentum. Additionally, previous underweights in Japan and UK are neutralising, as earnings have improved. Japan’s economic recovery remains strong, with inflation under control. Our optimistic view on such developed markets is funded by exposures from Canada, which are being brought back to neutral.

Elsewhere, there is a reduction on our overweight to Asia Pacific ex-Japan. While earnings in Australia appear weak, it is believed that valuation of the region remains attractive. There is an underweighting of emerging markets, as earnings have deteriorated and China’s recovery has shown signs of slowing. However, China’s policy changes for any upside opportunities are being closely monitored.

Across fixed income, 20+ year US Treasury positions are neutralised and our underweight in high yield is reduced as supported by improved spread momentum. Overall portfolio duration has increased by around 0.1 year.

Within alternatives, TIPS exposures are trimmed back to neutral. Living with higher inflation is still a possible scenario, but there appears to be more downward pressure on inflation, particularly rent inflation. For diversification purposes, GOLD and REITS allocations are kept in the portfolio.