Balanced ETF portfolios CHF 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 (30/09/2023)

Performance

The portfolios delivered negative returns in Q3, driven by an exceptionally difficult September, fueled by concerns surrounding persistent inflation and that interest rates are expected to stay higher for longer. In September, within equities, the main detractors were US equities, followed by European equities, while emerging market equities were more muted. Japanese equities continued to contribute positively to performance in September. Within the fixed income sleeve, governments bonds detracted the most, as yields rose during the month, led by poor performance of the mid-longer dated treasuries. The commodities sleeve acted as a diversifier during the month.

Latest rebalance rationale

The rebalance will increase risk by increasing the equity allocation across the range. Market volatility is moderating, and the growth-inflation trade-off is starting to look more optimistic.

Within equities, the allocation in Moderate and Aggressive risk profiles is increased by 2.5% and 4%. In the U.S., decelerating inflation, resilient fundamentals and the AI-related boom have been supporting valuations. In doing so, it is preferred to allocate to unhedged U.S. equities over their EUR-hedged versions.  Japanese equities continue to show as a diversifier in the portfolio, with rising inflation being a likely tailwind, potentially leading to increased wages and improved pricing power. In turn, allocations to EMU and Swiss equities are reduced. The underweight sentiment to EM equities is reduced on the back of cheaper valuations. Additionally, there is a reduction in the allocation to global clean energy equities. This comes as underlying solar and wind companies have been continuing to struggle with weak profit margins.

Within fixed income, there are reduced allocations to cash-like 0-3 yr. Swiss government bonds in the Moderate and Aggressive profiles to fund the allocation to equities, whilst adding to it in the Conservative profile, to keep portfolio duration consistent. Within credit, allocations to local currency EM debt are reduced and allocated to USD corporate bonds. Though credit spreads have tightened year-to-date, it is preferred to be up in quality within fixed income and instead add to portfolio risk through equities. The allocation to commodities remains unchanged.