Stronghold EUR update: The intense days of March 2020 to cut risk

March 2020 will go down as one of the most dramatic months in financial markets and an acid test of the ETF market. The Stronghold EUR model had cut equity exposure to zero in February and was coming into March being the most defensive since the portfolio's inception in July 2017. Despite the portfolio being defensive markets became highly correlated and liquidity became erratic in some the ETFs that Stronghold EUR was exposed to.

Even though Stronghold EUR leaves the first quarter with a negative quarterly return, it has performed decently when comparing to other tactical asset allocation portfolios with similar risk levels. Comparing to the BlackRock EUR portfolios on Saxo Bank's SaxoSelect offering, the Stronghold return for the first quarter lies between the quarterly return for the BlackRock Defensive and BlackRock Moderate Defensive portfolios.

The Stronghold EUR model started March well as credit and inflation-linked government bonds were bid but then the US Treasury market and inflation-linked bonds began a historic dislocation due to margin calls and collapsing inflation expectations. The model had to reduce risk multiple times during the month starting on 16 March selling all exposure to investment grade corporate bonds and majority of exposure to inflation-linked bonds. The spreads had already widened and liquidity was terrible. The trade-off was between high trading costs hitting the portfolio value or staying within our risk budget. The latter is most important at all times so we had to eat the increased friction and trading costs in ETFs. Two days after on 18 March the portfolio's covered bond exposure was cut to zero as mortgage bonds in Europe went in free fall relative to normal volatility; there were no places to hide as investors were in a 'dash for cash'. Even gold became correlated and acted as a risky asset such as equities. The 18 March was an extraordinary intra-week rebalancing as the estimated portfolio risk was too far away from our target. On 18 March asset classes became so correlated that we had to add 0-1 year Euro government bonds with a 20% maximum weight in order for the model to stay within the risk budget. This was not something we had seen during the financial crisis in 2008 during our simulations.

Finally on 23 March the model reduced some of its 10-year global government bonds exposure and increased exposure in Euro 1-3 year government bonds. Despite the aggressive actions of the model the portfolio was down 6.5% in March compared to minus 3.7% for the benchmark. The reason for this difference is driven two factors. The benchmark is static with quarterly rebalancing so trade costs are minimal. Stronghold EUR had to sacrifice some performance to maintain its strict focus on minimizing risk. The second factor is that Stronghold EUR went ultra-defensive with 80% exposure in Euro government bonds across the 0-1 year and 1-3 year segments and zero equity exposure so when the 18% rebound in global equities came Stronghold EUR did not get any return from that. Meanwhile the benchmark has a 35% exposure to global equities.

Year-to-date Stronghold EUR is down 8.6% compared to 7.1% for the benchmark portfolio. With many economists expecting a bigger hit to the economy from COVID-19 than the 2008 crisis financial markets will continue to be volatile and in the case equities continue to fall Stronghold EUR will benefit relative to the benchmark.