Gain Strategies
After a furious and volatile start to the year for stock and bond markets, the second quarter provided a welcome respite for investors still trying to recover from the difficult market conditions in 2022. Trends were broadly consistent throughout the quarter both at the asset class level and within stock and bond markets. The start of the quarter featured stability for markets after the shock failure of a few banking institutions in the U.S. in mid-March. While investors were not terribly nervous heading into the debt ceiling showdown in late May, the combination of a bi-partisan deal and incredibly resilient economic data in the face of higher interest rates drove strong gains in equities in both absolute terms and relative to core fixed income markets. Within global equity markets, trends throughout the quarter were relatively stable; domestic large caps (S&P 500 Index), led by mega-caps tech names that also happen to have an outsized weight in the popular NASDAQ 100 Index, outperformed both international markets (MSCI ACWI ex-US Index) and domestic small caps (S&P 600 Index). This anti-cyclical price action was confirmed by the underperformance of Europe (MSCI Europe Index), emerging markets (MSCI EM Index), domestic value (S&P 500 Value Index), and domestic dividends (Dow Jones Select Dividend Index). Within fixed income markets, government yields rose across all maturities, and the yield curve inverted further, leading to small losses on core investment-grade bonds (Bloomberg US Aggregate Index) over the quarter. Credit spreads declined as investors recalibrated their economic outlook, leading to modest outperformance for shorter duration and lower credit quality market segments of the corporate bond market. Measures of implied volatility across fixed income and equity markets declined during the quarter and provided a further tailwind to the market environment.
Throughout the quarter, Horizon’s Gain models maintained a full equity allocation. The persistence of trends within equity markets kept our positioning adjustment relatively modest during the quarter. We began the second quarter with an overweight to international stocks, favoring Asia, and a domestic growth bias. After slightly adjusting this positioning mid-quarter by increasing our smaller-cap allocations and tilting more toward domestic growth and quality, we moved toward the U.S. and slightly away from the mega-caps as the quarter came to a close. This move represented a tactical opportunity to capitalize on potential investor rebalancing after a strong quarter and year for the top of the domestic equity market.
In the fixed income allocation of the Gain models, the quarter began with overweights to corporate credit and mortgages and underweights to Treasuries. This riskier allocation proved beneficial during the quarter as market conditions improved; we maintained this stance throughout, given the persistence of trends within fixed income markets. Core rates rose sharply during the quarter, causing our slightly longer-than-benchmark duration positioning to lag. We continue to view this stance as a cost-effective hedge to our higher-risk credit exposures and would note that the risk-reward tradeoff of longer-duration positioning increased toward the end of the quarter as long-term yields and high-yield credit spreads approached their levels in early March before regional banks came under pressure.
Gain Equity Contributors and Detractors
The biggest contributors to performance in the equity portfolio last quarter were domestic large-cap exposures with a growth tilt. Specifically, mega-cap technology, quality factor exposure, and growth contributed the most to performance in the second quarter. Domestic small-size factor exposure, domestic mid-caps, and China contributed the least to returns.
Gain Fixed-Income Contributors and Detractors
In the fixed-income portfolio, emerging market bonds, and high-yield corporate bond exposure to both the broad universe and a higher-quality, longer duration segment contributed the most to performance last quarter. Intermediate-term U.S. Treasuries, mortgage-backed securities, and a tactical core bond holding contributed the least to performance in the second quarter.
Protect Strategies
Horizon’s Protect portfolios started the second quarter with only marginal de-risked allocations after the flurry of reinvesting activity to start the year. All models fully reinvested in their target equity and fixed income allocations during the second quarter, bringing the setting of the Risk Assist algorithm to its default “off” position. Furthermore, as market conditions improved throughout the quarter, all models ratchetted, establishing new levels from which to measure drawdowns and calibrate future potential de-risking activity. Updated ratchet levels can serve an important role in helping manage portfolio values if the positive equity trend meaningfully reverses course.
In line with our standard portfolio construction design, the tactical tilts in our Protect equity portfolios were broader and less focused than in our Gain portfolios. In fact, due to the persistence of trends within equity markets, our underlying allocation was unchanged throughout the quarter. Our Protect equity allocation featured a smaller tilt toward growth and mega-cap names in the U.S. market, a higher market cap profile, and less concentration in Asia compared to our Gain portfolios. Additionally, the Protect portfolios held small strategic allocations to the low volatility factor to improve Risk Assist interaction in shallow market pullbacks.
The fixed income allocation of our Protect portfolios featured similar stability to our equity positioning. Because of the persistence in trends in the fixed income market, we did not adjust our stance during the quarter. Highlights of our current positioning include an overweight to credit, especially higher-yielding market segments, an overweight to mortgage-backed securities, an underweight to U.S. Treasuries, and a small allocation to emerging market bonds. We balanced this positioning by maintaining a slightly longer duration profile during the quarter.
Protect Equity Contributors and Detractors
The biggest contributors to performance in the equity portfolio last quarter were domestic large-cap exposures with a growth tilt. Specifically, mega-cap technology, quality factor exposure, and growth contributed the most to performance in the second quarter. Low volatility exposures to domestic large-caps and international markets and regional exposure to Asia contributed the least to performance in the second quarter.
Protect Fixed-Income Contributors and Detractors
In the fixed-income portfolio, emerging market bonds, and high-yield corporate bond exposure to both the broad universe and a higher-quality, longer-duration segment contributed the most to performance last quarter. Intermediate-term U.S. Treasuries, mortgage-backed securities, and a tactical core bond holding contributed the least to performance in the second quarter.
Spend Strategies
The market environment in the second quarter continued its favorable trend as investors sought to put the difficult conditions of 2022 firmly in the rearview mirror. Almost all of the Spend models began the quarter slightly de-risked, but that quickly changed – by mid-April, all of the Spend models were fully allocated to their underlying growth allocations. Equity markets continued to rally throughout the quarter, leading to ratchet activity across all Spend models. Updated ratchet levels can serve an important role in helping manage portfolio values and minimizing the sequence of return risk if the positive equity trend meaningfully reverses course. For the first time since the end of 2021, the spending reserves across all models contain the full twelve quarters of spend. This was due to our standard rebalancing process following the models’ performance in the second quarter.
Spend Portfolio Positioning
The core design feature of Horizon’s Spend portfolios, featuring a tilt toward risk-managed equity, underweight to core fixed income, and an appropriately calibrated spending reserve, was a tailwind to model performance in the second quarter. Global stocks, as represented by the MSCI ACWI Index, exceeded core bonds, as proxied by the Bloomberg US Aggregate Index, by about 7% on a total return basis. Our equity allocation lagged global stocks slightly due to the slight low volatility and dividend tilts in the portfolio, while the fixed income allocation benefitted from an overweight to credit markets. The spending reserve replenishment resulted in a slightly decreased allocation to the investment portion of the models. The inverted yield curve provided an opportunity to increase the portfolio yield while lowering interest rate exposure. As part of the rebalancing process, we increased the yield of the spending reserve by moving the Treasury allocation from short-term (1 to 3-year) notes to Treasury bills.
Spend Contributors and Detractors
In the equity allocation of the Spend portfolios, domestic large-cap exposures, specifically core and growth tilts, contributed the most to returns last quarter. Domestic small-cap low volatility factor exposure and value-tilted dividends contributed the least in the second quarter. In our fixed-income allocation, exposure to high-yield corporate bonds contributed the most to performance, while our core investment-grade bond allocation contributed the least to performance.
Market Outlook
As we close the books on the first half of the year, it is helpful to look back on where we started the year and how things have evolved. At the start of the year, the dominant narrative was one of an imminent recession and a rocky start for asset markets, followed by Fed cuts and a better second half for investors. Instead, growth, especially in the US, has rebounded, the labor market has remained healthy, interest rates are near their highs, and stocks have enjoyed a strong rally. Our work had us doubting this narrative to start the year, and we have moved further away from that line of thinking as time passed. Looking forward, we continue to see a tight labor market pushing out the timeline for a recession and a better balance to Fed policy, providing some clarity for investors on valuations. The last nine months are a good reminder of why Horizon believes in the long-term value of tilting portfolios toward equity markets while managing through changing trends and challenging market environments with what we consider to be robust and sophisticated risk management techniques. We are thankful for your trust and hope you have a wonderful summer.
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. Opinions referenced are as of the date of publication and may not necessarily come to pass. Forward-looking statements cannot be guaranteed. We do not intend and will not endeavor to provide notice if and when our opinions or actions change.
The S&P 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The Dow Jones U.S. Select Dividend Index aims to represent the U.S.’s leading stocks by dividend yield. The S&P 500 Value Index is comprised of the value stocks in the S&P 500 Index. The S&P Small Cap 600 Index consists of 600 small-cap stocks. A small-cap company is generally defined as a stock with a market capitalization between $300 million and $2 billion. The MSCI Europe Index is designed to measure the performance of the large and mid-cap segments of the European market. The MSCI ACWI ex-U.S. captures large and mid-cap representation across 22 Developed Markets and 24 Emerging Markets countries, excluding the U.S. The MSCI Emerging Markets Index captures large and mid-cap representation across 24 Emerging Markets countries. References to indices or other measures of relative market performance over a specified period of time are provided for informational purposes only. Reference to an index does not imply that any account will achieve returns, volatility, or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change.
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 losses. 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.
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
Horizon Investments, the Horizon H, Gain Protect Spend, Risk Assist, and Real Spend are all registered trademarks of Horizon Investments, LLC.
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