Happy New Year, we hope that you had a safe and enjoyable holiday period and from the Innova team we welcome you into 2023.
2022 was a volatile and tumultuous year – one which many investors would like to forget, but one which we believe lessons can be learned from to help better navigate the year ahead of us.
To help illuminate our research, analysis and thought processes around some of the changes we made in 2022 – as well as to assess how those themes went and what we can learn about positioning for this year – we wanted to review our six major rebalances throughout last year for our clients.
These rebalances are reflected on our usual Portfolio Changes Report, as seen below:
February 2022: Switching Europe to UK Equity exposure
Our switch to UK equities, via an exposure to the FTSE 100, was driven by a combination of lesser geopolitical risks and attractive relative valuation – where Europe was trading at a premium to the UK, which had trailed over several years, and was fundamentally primed for a mean reversion move.
This is a call that we have held all year and it has continued to serve the portfolios well: as of 31 December 2022, the FTSE 100 was the only broad developed market equity index to have a positive year in local currency terms:
| As at 31/12/22 | 3 Months | 6 Months | 1 Year |
| FTSE 100 | 8.68% | 5.64% | 4.31% |
| MSCI Europe | 9.61% | 5.15% | -9.12% |
Whilst we are satisfied with this position and its additive qualities to the portfolio, we also recognise that a large relative move has occurred between the UK and European markets now – with markets increasingly repricing European equities away from “everyone’s going to freeze, starve and lose their job”, we are keeping a close eye on valuation levels for a potential pivot back towards a more diversified exposure in the future.
April 2022: Reduced cash, increased credit
We increased our allocation to credit multiple times throughout the year, seeing investment-grade, floating-rate credit as one of the best risk-adjusted asset class profiles of 2022.
On the positive side, Aussie floating rate credit was the only area of the fixed income market which saw a positive year in 2022 (local currency terms)– particularly relative to long-duration government bonds, which infamously had one of the worst years on record for the asset class:
| As at 31/12/22 | 3 Months | 6 Months | 1 Year |
| AusBond Credit FRN | 0.92% | 1.64% | 1.28% |
| AusBond Treasuries | 0.24% | -0.48% | -10.46% |
| US Credit Aggregate | 3.63% | -1.61% | -15.60% |
| US Treasury Aggregate | 0.72% | -3.66% | -12.33% |
With the benefit of hindsight, our choice of funding source was not optimal. Our view that cash was yielding a negative real return was not incorrect, however being long cash in the face of sinking asset prices turned out to be one of the better positions a multi-asset portfolio could have held throughout 2022.
May 2022: Sold A-REITs
In May, A-REITs boasted very few attractive characteristics; the yield on the ASX 200 A-REIT index was below that of the general ASX 200 index, their valuations were expensive relative to historical levels and global property, and their interest rate sensitivity was unknown.
On balance, that was a good call to make, and despite solid performance in the past few months, the index is still heavily negative on a whole of 2022 basis, with 6m performance being dragged up by a strong October-December period:
| As at 31/12/22 | 3 Months | 6 Months | 1 Year |
| ASX 200 A-REIT | 11.53% | 4.04% | -21.64% |
| ASX 200 | 9.40% | 9.82% | -1.98% |
| FTSE NAREIT Index | -1.70% | -7.01% | -19.63% |
The market is now at the stage that certain elements of real assets look attractive, particularly global property (G-REITs), where valuations and pricing are reflecting an economic slowdown far in excess of many other risky asset markets. Given their recent strength and still un-compelling yield profile, A-REITs are still not a screaming buy, but they do look better than when we sold them.
May 2022: Sold Asia, bought FOOD
As part of our de-risking process in the portfolios, we elected to remove our Asia ex-Japan exposure in a bid to remove a high volatility, high beta asset during a period of enhanced uncertainty – it is difficult (if not impossible) to forecast idiosyncratic risk, like geopolitical tension, and so taking risk off the table was in order.
The capital was deployed into a soft agriculture exposure via the FOOD ETF, which had a compelling valuation profile, was leveraged to the theme of supply chain reshoring and food scarcity, and had broad exposure across the agriculture supply chain.
| As at 31/12/22 | 3 Months | 6 Months | 1 Year |
| FOOD:ASX | 6.19% | 2.40% | -0.56% |
| MSCI Asia ex-Japan | 12.05% | -1.96% | -16.62% |
Our timing was mixed on these fronts, albeit the thesis behind the trades were sound. Asia was an exposure which may have represented a funding source for earlier trades, whilst FOOD (whilst a relative outperformer to many other global exposures) has had languishing performance in the back half of 2022.
Clients will know that we have recently re-allocated into Asia, given its valuation profile and high return forecasts from our models adequately compensating investors for any remaining qualitative geopolitical risks which are yet unknown by the market.
June 2022: Sold quality equities, increased credit
Global quality equities were another part of our de-risking process, anticipating further equity volatility and recognising that despite quality being a long-standing mainstay of the portfolio, it is value which is a better relative performer in periods of tightening liquidity and slowing growth. It’s also worth noting that we’d reduced our quality exposure going into 2022, as the common rhetoric that “quality performs well in downturns’ misses the point about value – and at the start of the year, they had reached nosebleed valuations. The sale in June was a further reduction from a sector we’d already reduced exposure to, which happened to be a poor relative performer compared to our Value exposures.
| As at 31/12/22 | 3 Months | 6 Months | 1 Year |
| MSCI World Quality | 10.17% | 2.30% | -22.44% |
| MSCI World Value | 14.94% | 6.82% | -5.67% |
| MSCI World Growth | 4.77% | -0.47% | -29.35% |
This was an effective call on a relative basis, where holding credit shielded the portfolio from sell-offs and volatility, whilst our overweight to value served our positioning much better than if we had maintained a quality exposure.
Quality is an area that we are keeping an eye on, where the fundamentals are better but not quite at price/valuation levels which we would consider “cheap” as of yet – but we’re hopeful we’ll be able to re-allocate at some point in the future
August 2022: Sold infrastructure, increased credit
Infrastructure was an asset which had held up remarkably well throughout 2022, not enduring the same sell-down as property and seemingly riding the wave of “inflation-linked cashflows” which investors were seeking throughout the year.
As part of our valuation focus, when an asset’s price has increasing divergence from other comparable assets (here property is the comparable), we take notice and if fundamentals do not support further growth, we look to exit and buy a more un-loved space. In particular, by August the inflation protection story had played out well, but the market’s focus was turning more towards security of cash flow as inflation started to reduce it’s acceleration. We think the focus will now shift from inflation protection to cash-flow security – this hasn’t yet played out, but is a very logical line of thought and there have been many historical precedents when this has occurred in the past
| As at 31/12/22 | 3 Months | 6 Months | 1 Year |
| S&P Infrastructure | 11.04% | 0.34% | 0.25% |
| ASX 200 A-REIT | 11.53% | 4.04% | -21.64% |
| FTSE NAREIT Index | -1.70% | -7.01% | -19.63% |
Like other real assets, Infrastructure had a strong October – December, however given the nature of our investment philosophy and the nature of managed accounts favouring smoother returns than attempting to time specific niche exposures, trying to catch this felt like a falling knife. The volatility since we sold it certainly would have made the second half of 2022 more uncomfortable for investors, so we chalk this up to a good relative call.
On to the new year
We can look back over 2022 with a level of satisfaction that the major calls we made were broadly on the mark, and served to defend in a volatile environment and generate relative outperformance.
Nobody has a 100% strike rate, except Bernie Madoff – incidentally, Netflix have a very well made documentary on his Ponzi scheme – however those calls that were spot-on were outstanding performers, and those that were mixed were not dramatic losses to the portfolio.
This places the portfolios, and client assets, in an exciting position to enter this new year – although the next 3-6 months are uncertain from a macro environment perspective, there is no shortage of opportunities already available, and we look forward to having our clients along for the journey.
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