The Horatius Fund Newsletter December 2019
2019 closed with a return of +0.34% in December, bringing the annual gain to +9.69%, net of all fees and expenses. This compares to a gain of +8.25% for our benchmark aggregate.
The new year started on an extremely strong note, which lasted precisely one day! Whilst ‘geopolitical risk’had been the most commonly expressed concern of most investors coming into 2020, no one was expecting that on the second trading day of the year, the hornets’ nest of Iran and the Middle East would have been poked quite so potently by the U.S. Although the immediate response of markets was the predictable spike in volatility and heightened risk aversion, it is telling the speed with which such initial fear dissipated, even in the most obviously affected areas such as oil. Within just a week, equity markets had recovered their poise and we now find U.S. markets registering new, all-time highs. This reaction reveals a couple of interesting points about markets’ current drivers. Firstly, the continued enormous importance of the bedrock of a low rate environment. The position of U.S. doves was certainly bolstered by a weak payroll figure of just 145,00 – a number barely in line with the number of new jobs required to keep pace with population growth and immigration. Secondly, and particularly in light of the previous point, that ‘geopolitical risk’, as often as not, represents just as much an opportunity as it does a risk. Third, the ongoing saga of talks between the U.S. and China is in an essentially benign phase: for what is generally cited as the second most important market factor (after geopolitical risks), this is thus a predominantly risk-supportive feature. Finally, the chronology of events in the Middle East provide another reminder that events rarely unfold in a predictable way: who could have predicted the twist that Iran would instantly squander any geopolitical benefit that they might otherwise have garnered had the tragic, erroneous shooting down of the Ukrainian airliner not occurred when it did?
Credit markets have had a more subdued start to the year than equities, with substantial diversion across the asset class. While the likes of South Africa, Mexico and Chile remain close to their recent wide spreads, Brazil, Turkey and Indonesia are testing new tights. Argentina remains in the doldrums and Lebanon looks increasingly likely to default and Zambia, too, is cause for concern. Recent events in Russia, too, are particularly pertinent to one of our longest-standing views: that the nature of Putin’s position creates a situation whereby the transition, as and when it may come, from Putin running the country to whoever his successor may be, is likely to be turbulent and potentially binary. His current pre-emptive manoeuvering is entirely consistent with our belief that he needs to retain power, probably for as long as he is alive – the problem being that, sooner or later, this will become increasingly difficult.
Clearly, stock-picking, at both a regional and a country level, remains crucial, as much in knowing where to avoid as much as where one should deploy capital. This also underpins another dynamic which we highlighted recently: the distinction between sovereigns and corporates in terms of the type of risk that one takes when exposed to each. Certainly, there are many corporates whose performance will be driven by the outlook of their respective sovereigns, whether this risk be actual or perceived. However, there are numerous corporates whose performance is largely independent of the sovereign and many of these benefit from what, in comparison with their developed market peers, are conservative capital structures, whilst still enjoying robust top line growth and strong margins – and whose bonds still offer attractive spreads. Such bonds will typically have much lower correlation with global or even local, geopolitical or macro events. The current portfolio significantly reflects this dynamic. The other ‘sector’ of the market where we find particular value is among mid-sized issuers, typically bonds between $200 and $400 million. Many of these names are relatively under-covered and are simply too small for the very large EM managers who require greater capacity to accommodate their size. Even though many are high quality businesses, often of ‘national champion’ status, their bonds still offer an attractive premium.
Although still only two thirds of the way through the month, this configuration has seen a strong start to the new year. The fund is currently up around 1.30% against the benchmarks’ average of 0.29%.
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