Saxo Morningstar Moat USD Q3 2021 commentary

Market overview

The global rally in asset prices has lost momentum in recent times. While some equity markets continue to post modest gains, the total return backdrop has faded in comparison to recent memory, with emerging markets being a particular sore point. Thus far, year-to-date returns still remain strong and the post-pandemic recovery intact. Several factors are at play, but the two prominent influences are inflation fears and the China regulatory crackdown. 

Inflation fears have been with us for most of 2021 yet continue to be regarded as the biggest tail risk—potentially derailing both equities and bonds. More recently, this has included central bank dialogue around a gradual tapering of its loose monetary conditions. While some see the inflation increase as being driven by a rebound from depressed prices in 2020 and/or temporary supply-chain issues, others point to massive fiscal and monetary stimulus contributing to a structural increase in inflation. The reopening of businesses is another contributor, although this has lost some steam as the delta variant continues to create economic challenges. 

The combination of rising inflation worries and central bank tapering translates into rising bond yields. This was perhaps the most noteworthy financial market move late in the third quarter of 2021, influencing the returns of both stocks and bonds. 

For equities, a rise in bond yields typically equates to downward pressure on stock prices—all else being equal—and that’s exactly what has been observed in the third quarter. The obvious exception to this were energy companies, which saw another meaningful boost to returns, supported by higher commodity prices. Japan was another rare bright spot. To the downside, it has been observed a  remarkable shift in Chinese technology companies and the potential bankruptcy of a large real estate developer, Evergrande. These developments in China carried some contagion fears, bringing down the entire emerging market basket and practically wiping the gains year-to-date. Small-cap stocks also fell late in the quarter, giving back some of their lead over to large-cap stocks in the past year.

For bonds, inflation fears are driving yields higher and have helped inflation-protected bonds outperform. On the other hand, nominal government bonds have failed to offset equity risk recently, generally posting modest negative returns. Longer-dated government bonds are now down meaningfully year-to-date, while emerging market bonds in local currency are also down. Higher-quality corporate bonds are generally doing better and broadly flat, despite a rise in volatility. Regarding currency moves,  recent strength has been observed in safe-haven currencies like the U.S. dollar.

Portfolio performance (net of fees)

Top 10 portfolio holdings (as of 30/09/2021)
40.16% of total portfolio

Top Performers

• Equitrans Midstream Corp: Equitrans acquired EQM Midstream in mid-2020, consolidating the midstream family. Equitrans now own EQM assets directly versus just unit ownership. EQM Midstream provides gathering, transmission, and water services to primarily Appalachian producers in Pennsylvania, West Virginia, and Ohio.
  
  
• ABN AMRO Bank NV: ABN Amro Bank is a Dutch bank, and the Netherlands accounts for around 90% of its operating profit. Operationally, retail and commercial banking contributes the bulk of its operating profit, while ABN Amro continues to reduce its exposure to corporate and investment banking. It views private banking as one of its key growth areas.
  
  
• WESCO International Inc: Wesco International is a value-added industrial distributor that has three reportable segments, electrical and electronic solutions, communications and security solutions, and utility and broadband solutions. The company offers more than 1.5 million products to its 125,000 active customers through a distribution network of 800 branches, warehouses, and sales offices, including 42 distribution centres. Wesco generates 75% of its sales in the United States, but the company has a global reach, with operations in 50 other countries.
  
  
• ING Groep NV: The merger of the Dutch postal bank and NN Insurance in 1991 created ING. Through a series of further acquisitions ING build up a global footprint. The 2008 financial crisis forced ING to seek government support--a precondition of which was that ING should separate its banking and insurance activities, which saw ING revert to being solely a bank. ING has market- leading banking operations in the Netherlands and Belgium, and a range of digital banks across Europe and Australia. Its global wholesale banking operation is primarily focused on lending.
  
  
• CVS Health Corp: Following its acquisition of Aetna in late 2018, CVS Health now provides an even more integrated healthcare-services offering for its members. Legacy CVS combined both the largest pharmacy benefit manager, processing over 2 billion adjusted claims annually, and a sizable pharmacy operation, including nearly 10,000 retail pharmacy locations primarily in the U.S. Adding a managed-care organization with over 23 million medical members gives the company a strong position in the insurance industry and should help CVS better control overall healthcare costs for its clients.
  
   

Worst Performers:

• Link Administration Holdings Ltd: Link provides administration services to the financial services sector in Australia and the U.K., predominantly in the share registry and investment fund sectors. The company is the largest provider of superannuation administration services and the second-largest provider of share registry services in Australia. Link acquired U.K.-based Capita Asset Services in2017; this provides a range of administration services to financial services firms and comprises around 40% of group revenue. Link’s clients are usually contracted for between two and five years but are relatively sticky, which results in a high proportion of recurring revenue. The business model's capital-light nature means cash conversion is relatively strong.
  
  
• Ionis Pharmaceuticals: Ionis Pharmaceuticals is the leading developer of antisense technology to discover and develop novel drugs. Its broad clinical and preclinical pipeline targets a wide variety of diseases, with an emphasis on cardiovascular, metabolic, neurological, and rare diseases. Ionis and partner Biogen brought Spinraza to market in 2016 as a treatment for a rare neuromuscular disorder, spinal muscular atrophy. Ionis subsequently brought two additional drugs to market via its cardiovascular-focused subsidiary Akcea, including ATTR amyloidosis drug Tegsedi (2018) and cardiology drug Waylivra (Europe,2019).
  
  
• Just Eat Takeaway.com NV: Just Eat Takeaway operates an online marketplace that connects restaurants with users in Europe and North America. The company operates mainly as an order-only marketplace, although it also offers last-mile delivery services. The company is the result of the merger of Just Eat Plc and Takeaway.com NV in early 2020. The company had close to 60 million active users on its platform generating revenue of about EUR 2 billion and a gross merchandise value of EUR 13 billion. Excluding the U.S. after its recent acquisition of Grubhub, the company’s largest geographical presence by revenue is in the U.K., followed by Germany, Canada, and the Netherlands.
  
  
• AGL Energy Ltd: AGL Energy is one of Australia's largest retailers of electricity and gas. It services 3.7 million retail electricity and gas accounts in the eastern and southern Australian states, or about one third of the market. Profit is dominated by energy generation, underpinned by its low-cost coal-fired generation fleet. Founded in 1837, it is the oldest company on the ASX. Generation capacity comprises a portfolio of peaking, intermediate, and base-load electricity generation plants, with a combined capacity of 10,500megawatts.
  
  
• TAL Education Group ADR: Founded in 2003, TAL Education is one of the leading K-12 after-school tutoring providers in China. The firm offers tutoring services to students from pre-school to the twelfth grade via small classes, one-on-one personalized premium services, and online courses. In fourth quarter fiscal 2021, TAL's small classes account for 53% of its revenue, one-on-one 6%, and Xueersi.com 32%. Its tutoring services cover the core academic subjects in China’s school curriculum, such as Math (K-12), English (K-12), Chinese (K-12), Physics (Grade 8-12), Chemistry (Grade 9-12), and Biology (Grade 10-12). TAL's learning centers currently cover 101 cities in China and a total of 1,098 learning centers. In fourth-quarter fiscal 2021, current normal priced long-term course student enrolment was 6.7 million.

Outlook

The supportive environment is evolving quickly, and all eyes appear to be on inflation at the moment. Regarding the recovery, most of the cyclical upswing may now be in the past, although positives are still being observed. 

In a forward-looking sense, many market participants are still encouraged by the economic recovery, with strong corporate earnings and cheap interest rates, and so continue investing at full speed. Others are beginning to question the durability of the recovery. This type of bifurcation among market participants is very normal at this stage of a recovery, as economic maturity increases, and the positive dataflow somewhat softens. In this regard, the portfolio is broadly positioned for a continuation of the economic recovery, reducing some of the cyclical positioning and retaining a defensive ballast.