Gain Strategies
The second quarter of 2022 was another difficult one for asset markets as investors continue to grapple with the outlook for inflation and growth amid a backdrop of rapidly shifting monetary policy expectations and persistent geopolitical tensions. Both global stocks [MSCI ACWI Index (MXWD)] and core bonds [Bloomberg U.S. Aggregate Index (LBUSTRUU)] fell last quarter, adding to their poor returns in the first quarter. There was considerable volatility at the broad index level, as well as under the hood, in terms of styles, regions, and factors, likely exacerbated by poor liquidity conditions and investor uncertainty. In line with Horizon’s portfolio design for Gain stage investors, our accumulation models maintained a full equity allocation throughout the quarter. However, the positioning in our equity portfolio was broadly defensive for the second straight quarter. Our team’s views led to a similar defensive posture in our fixed income allocation.
In our Gain equity allocation, we entered the quarter with a modest overweight to domestic stocks and a strong value and defensive bias. Internationally, we began the quarter positioned in favor of Asia over Europe. As the quarter went on, we increased these tilts, moving more toward U.S. defensive and value allocations at the expense of emerging markets. We also increased our domestic small- and mid-cap exposures as these companies are generally less exposed to economic growth conditions outside the U.S. Our equity allocation generally exhibited defensive properties versus broad passive equity benchmarks throughout the second quarter, in line with our expectations.
Volatility in the fixed income market was also elevated during the quarter, and the MOVE Index, a measure of option-implied volatility for U.S. Treasuries, touched levels last seen during the 2020 Covid drawdown. We entered the quarter with a higher quality profile than we have had since the first half of 2020, as well as a meaningful underweight to mortgage-backed securities. As the quarter went on, we lowered our overall duration exposure and tactically added high yield corporate credit exposure as spreads widened. Adding that spread exposure to the portfolio was too early, however, and as volatility continued to rise we removed that tactical exposure and our other higher yielding tilts in favor of short-term U.S. Treasuries and mortgage-backed securities. Those reallocations decreased our duration profile and raised our quality profile further. Q2 2022 Quarterly Report | page 9
Gain Equity Contributors and Detractors
The biggest contributors to the performance of the Gain equity portfolio last quarter were domestic energy exposure, emerging markets, and domestic large cap dividend factor exposure. Contributing the least to returns were domestic large-cap value, domestic small size factor exposure, and domestic mega cap technology.
Gain Fixed-Income Contributors and Detractors
In the fixed-income portfolio, interest rate sensitivity was once again the main driver of returns as interest rates rose throughout the quarter. Short-term U.S. Treasuries, mortgage-backed securities, and short-term investment grade corporate debt contributed the most to performance last quarter. Long-term U.S. Treasuries, long-term investment grade corporate debt, and a tactical core bond holding contributed the least to performance.
Protect Strategies
After a volatile start to the year for global equity and fixed income markets, some of Horizon’s Protect portfolios began the second quarter with a partially de-risked allocation to short-term U.S. government debt. Selling pressure across markets resumed throughout April and the first half of May as investors continued to reprice expectations for inflation, growth, and Federal Reserve policy. During this time, Horizon’s Risk Assist® algorithm engaged to systematically de-risk the Protect portfolios in order to attempt to mitigate drawdowns. By the end of the quarter, all the Protect portfolios finished with a meaningful de-risked allocation, although some portfolios had partially re-risked from their most conservatively positioned levels. The Risk Assist® activity mitigated some of the drawdowns across markets in the second quarter while also lowering overall portfolio volatility.
In the underlying equity allocation in the Protect portfolios, our tactical tilts at the beginning of the quarter were broadly similar to those in the Gain equity allocation, although they were expressed in a less-focused manner than in the Gain models. That included an overweight to the U.S. with a defensive bias and a strong tilt toward value stocks. Toward the end of the quarter, once Risk Assist® had meaningfully engaged to de-risk the portfolios, we neutralized these tactical tilts in our equity portfolio to make the underlying equity allocation more market-like in order to improve potential up-capture if market trends were to reverse. Specifically, that included trimming domestic allocations to value and defensive sectors in favor of growth, small caps, and international exposures.
The fixed income market was also volatile throughout the quarter, and similar to our positioning in the Gain portfolios, Horizon’s Protect fixed-income allocations carried a generally defensive bias. At the beginning of the second quarter, our allocation was higher in quality than it has been in some time. Due to the potential negative impact of the Federal Reserve’s plan to shrink its balance sheet, we were meaningfully underweight mortgage-backed securities. Interest rates increased throughout the quarter and volatility rose, leading us to lower our overall duration exposure. Credit spreads widened materially during the quarter, and we acted to take advantage of more attractive valuations in the high yield corporate sector for a tactical trade. However, our timing was too early, and as market conditions continued to deteriorate we removed this tactical exposure and our other remaining high yield tilts. This final reallocation resulted in a lowering of our duration profile and a pronounced quality bias in our sector and credit allocations.
Protect equity contributors and detractors
Due to their broadly similar tactical tilts (notwithstanding the interactions of the Risk Assist® algorithm), the leaders and laggards in the underlying equity portion of the Protect portfolios were similar to those in the Gain portfolios. Emerging markets, domestic defensive dividends, and domestic large-cap growth contributed the most to performance during the second quarter. Broad international developed markets, domestic small size factor exposure, and domestic mega cap technology contributed the least to returns.
Protect Fixed-Income Contributors and Detractors
In the fixed-income portfolio, interest rate sensitivity was once again the main driver of returns as interest rates rose throughout the quarter. Short-term U.S. Treasuries, mortgage-backed securities, and short-term investment grade corporate debt contributed the most to performance last quarter. Contributing the least to performance were long-term U.S. Treasuries, long-term investment grade corporate debt, and a tactical core bond holding.
Spend Strategies
The second quarter proved challenging for Horizon’s Spend portfolios as losses for both stocks and core bonds deepened, continuing their volatile price action since the start of the year. These losses highlight the importance of maintaining a liquid reserve to fund current spending needs while not foregoing a potential recovery in the investment portion as part of a retirement spending solution. Per the design of our “intelligent rebalancing” program, the Spend portfolios did not replenish their spending reserves in the second quarter. Risk Assist® also engaged in the second quarter as losses across stock and bond markets deepened, although de-risking activity in the Spend models was more muted than in comparable Protect portfolios due to differences in portfolio construction.
Spend Portfolio Positioning
The core allocation decision of the Spend portfolios, tilted away from core bonds and toward equity markets, is designed to support retirement spending in today’s low interest rate world. This tilt, while not beneficial during the second quarter as global stocks [MSCI ACWI Index (MXWD)] under performed core bonds [Bloomberg U.S. Aggregate Index (LBUSTRUU)], was somewhat mitigated by the spending reserve and the hedging activity of the Risk Assist® algorithm. Our underlying allocation changes were modest last quarter. Similar to our activity after the first quarter, the lack of a spending reserve replenishment led to a slight increase in the investment portion of the models, in line with our standard portfolio rebalancing practices.
Spend Contributors and Detractors
In the equity allocation of the Spend portfolios, exposures to small cap domestic low volatility, domestic dividends, and international low volatility stocks contributed the most to returns in the second quarter. Holdings in the domestic large cap space, including value, growth, and core exposures, contributed the least last quarter. In our fixed-income holdings, exposure to senior loans contributed the most to performance, while our long-term investment grade corporate bond exposure lagged.
Market Outlook
All throughout the post-global financial crisis era, investors have been conditioned to expect salvation, in the form of central bank easing, any time equity markets experience significant turbulence. The price action in 2020 was the apotheosis of this dynamic, showcasing a phenomenon so powerful as to christen an entirely new cohort of retail traders whose creed, “stocks only go up,” plainly expressed what many investors had privately felt during the prior decade-long expansion. However, we do not believe that this model is well suited to today’s environment. That is because inflation, not growth, is the number one concern of central bankers, politicians, and the general public. Given that backdrop, we believe market volatility is likely to remain elevated in the coming months as investors grapple with the macroeconomic and geopolitical outlooks. While our views on these top-down issues have been the driver of our conservative portfolio positioning for the past few months, earnings season, starting in mid-July, may provide valuable bottom-up information to supplement our outlook. One thing is certain – volatility uncovers potentially attractive investment opportunities. The investment team at Horizon Investments looks forward to continuing to execute on our innovative portfolio strategies in order to help our clients meet their financial goals in the years ahead.
DISCLOSURES
Past performance is not indicative of future results. The investments recommended by Horizon are not guaranteed. There can be economic times when all investments are unfavorable and depreciate in value. Clients may lose money. This information should not be considered to be a recommendation to buy or sell any security or to adopt a particular investment strategy. It should not be assumed that any of the transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein.
RiskAssist® is NOT A GUARANTEE against loss or declines in the value of a portfolio; it is an investment strategy that supplements a more traditional strategy by periodically modifying exposure to fixed income securities based on Horizon’s view of market conditions. While Risk Assist was designed with the goal of limiting drawdown, Horizon is not able to predict all market conditions and ensure that Risk Assist will always limit drawdown as designed. Accounts with Risk Assist® are not fully protected against all loss. Furthermore, when Risk Assist® is deployed (whether partially or entirely) to mitigate risk for an account, the account will not be fully invested in its original strategy, and accordingly during periods of strong market growth the account may underperform accounts that do not have the Risk Assist® feature.
The Real Spend® retirement income strategy is NOT A GUARANTEE against market loss and there is no guarantee that the Real Spend® strategy chosen by an investor will lead to successful investment outcomes for part of, or for the entirety of an investor’s retirement. This strategy is not an insurance product with payments guaranteed. It is a strategy that invests in marketable securities, any of which will fluctuate in value. Before investing, consider the investment objectives, risks, charges, and expenses of the strategy. Keep in mind investing involves risk. The value of an investment will fluctuate over time and will gain or lose money.
Horizon Investments, the Horizon H, Gain Protect Spend, Risk Assist and Real Spend are all registered trademarks of Horizon Investments, LLC.
© 2022 Horizon Investments, LLC.
NOT A DEPOSIT | NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
NOT GUARANTEED | CLIENTS MAY LOSE MONEY | PAST PERFORMANCE NOT INDICATIVE OF FUTURE RESULTS
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