Gain Strategies
After a surprising and surprisingly positive first half of the year for financial markets, the recovery from the challenging market conditions of 2022 took a step back in the third quarter. Global stocks registered a minor down quarter to end with their first such losses since the third quarter of last year. But the real action was in the bond market. Long-term interest rates surged to pre-Global Financial Crisis highs as a more resilient economy and “higher for longer” signaling from the Fed collided with increased Treasury supply, dysfunction in D.C., and a sharp rally in crude oil. Negative stock and bond market sentiment afforded few places to hide last quarter; of the major market segments we track, only the domestic energy sector and some shorter duration segments of the fixed income market notched positive total returns. Measures of implied volatility across fixed income and equity markets and the US dollar rose moderately during the quarter, reflecting the less constructive market backdrop.
Equity market losses, while modest in magnitude in the third quarter, were broad-based with little dispersion. Domestic and international stocks (S&P 500 and MSCI ACWI ex-US, respectively) finished the quarter on top of each other. Within the domestic equity market, investors preferred higher quality and more defensive stocks and shunned more growth-sensitive areas of the market, like small caps. Internationally, Japan and China, both idiosyncratic stories, stood out on the positive side, while European bourses had a difficult quarter. Taking the quarter as a whole, price action was decidedly conservative and anti-cyclical.
Within fixed income markets, yields rose across all maturities. However, counter to the year-to-date trend of further inversion, the yield curve steepened as long-term Treasury yields rose considerably more than short-term Treasury yields. Long-term Treasuries were down double-digits, deepening their historic drawdown that began in 2020, while core investment-grade bonds (Bloomberg US Aggregate Index) realized their worst quarter in a year. Credit markets, likely supported by strong corporate fundamentals, were broadly unaffected by the market volatility and negative equity sentiment.
Throughout the quarter, Horizon’s Gain models maintained a full equity allocation. Although market volatility increased, underlying trends were largely consistent throughout the quarter, as reflected in our modest positioning adjustments. The third quarter began with positioning neutral on domestic and international stocks, overweight to domestic quality and growth stocks, and focused on Asia in the international portion of the portfolio. We also carried a relatively sizable exposure to domestic small caps. In the two adjustments to positioning in the quarter, we reduced our smaller-cap allocations and our international allocations to emerging markets in Asia and Europe, largely in favor of domestic large-caps. While our moves to increase domestic exposure were the largest in terms of overall magnitude, we added smaller allocations to domestic energy. We focused our international selection in Japan, utilizing local currency and FX-hedged exposures.
In the fixed income allocation of the Gain models, our sector allocations were broadly constant during the quarter, with overweights to corporate credit and mortgages and underweights to Treasuries. This riskier corporate credit allocation benefitted from shorter-than-benchmark duration and led to significant relative returns as rates rose sharply across the curve during the quarter. We reallocated this portfolio once over the quarter, de-risking our emerging market bond holdings and trimming nominal Treasuries in favor of TIPS and corporate credit. Despite the move higher in Treasury yields, we continued to view long-end Treasuries as an effective hedge in the event of weakness in corporate credit markets.
Gain Equity Contributors and Detractors
The biggest contributors to performance in the equity portfolio last quarter were allocations to the domestic energy sector, China, and currency-hedged Japan exposure. The domestic small-size factor, domestic quality dividends, and domestic large-cap growth contributed the least to returns.
Gain Fixed-Income Contributors and Detractors
In the fixed-income portfolio, shorter-term US Treasuries, short-term investment grade corporate credit, and emerging market bonds contributed the most to performance last quarter. Longer duration exposures, including long-term investment grade corporate credit, mortgage-backed securities, and a tactical core bond holding, contributed the least to performance in the third quarter.
Protect Strategies
Horizon’s Protect portfolios started the third quarter fully invested with the Risk Assist algorithm in its default “off” position. Equity markets rallied early in the quarter, leading to ratchet activity across all Protect models. This activity established new levels from which to measure drawdowns and calibrate future de-risking activity. Updated ratchet levels can serve an important role in helping manage portfolio values if the positive equity trend meaningfully reverses course, as it did during the third quarter.
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. Our underlying allocation maintained a smaller tilt toward growth and mega-cap names in the U.S. market, a higher market cap profile, and less international concentration than in our Gain portfolios. Additionally, the Protect portfolios held a larger overall allocation to the low volatility factor relative to the Gain portfolios, in line with the more defensive nature of the Protect suite, and intended to improve Risk Assist interaction in shallow market pullbacks. Indeed, despite the reversal in early market strength during the quarter, Risk Assist did not engage in any de-risking activity in the third quarter.
The changes to the fixed income component of the Protect portfolios mirrored those in the Gain portfolios; we de-risked our emerging market bond holdings and trimmed mid-curve Treasuries in favor of TIPS and corporate credit. Highlights of our current positioning include an overweight to credit, especially higher-yielding market segments, an overweight to mortgage-backed securities, and an underweight to U.S. Treasuries. 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 low volatility, Asia ex-Japan regional exposure, and international low volatility. Allocations to developed markets, domestic small-size, and domestic large-cap value contributed the least to performance in the third quarter.
Protect Fixed-Income Contributors and Detractors
In the fixed-income portfolio, shorter-term US Treasuries, short-term investment grade corporate credit, and emerging market bonds contributed the most to performance last quarter. Longer duration exposures, including long-term investment grade corporate credit, mortgage-backed securities, and a tactical core bond holding, contributed the least to performance in the third quarter.
1A ratchet refers to the resetting of the target loss tolerance threshold for the portfolio to a new (higher) value. Typically, in normal markets, Protect models ratchet with every 3%-5% appreciation in the portfolio’s value.
Spend Strategies
The market environment in the third quarter saw a reversal of the optimism of the first half of 2023. All of the Spend models began the quarter fully allocated to their underlying growth allocations and with a full twelve quarters of spend. The rally at the beginning of the quarter led to ratchet activity across most Spend models. Updated ratchet levels can serve an important role in helping manage portfolio values and minimizing the sequence of return risk if markets experience losses. Despite the reversal of markets in August, the Spend models saw no de-risking activity during the third quarter. For the quarter as a whole, given the performance of both stocks and bonds experienced, Spend models’ spending reserve were not replenished; all models began the fourth quarter with eleven quarters of spend.
Spend Portfolio Positioning
Global stocks and core domestic bonds both saw similarly sized losses during the third quarter, a challenge to any portfolio designed to support retirement spending. Horizon’s Spend portfolios used the spending reserve to fund current needs while not replenishing this spending, in effect increasing exposure to the equity-exposed portion of the portfolio. We also acted to increase the yield on the spending reserve by investing the cash portion of the models into Treasury bills. We made modest changes to the allocations within the growth portion of the models in the third quarter. Our equity allocation, which features an overweight to the US and some allocations to defensive securities like dividends and the low volatility factor, was largely in line with global stocks during the quarter. The fixed income portion of the Spend models maintained an overweight to corporate credit during the quarter.
Spend Contributors and Detractors
The biggest contributors to performance in the equity portfolio last quarter were emerging markets and international low volatility factor exposures. Allocations to domestic large-cap value and broad international developed markets contributed the least to performance in the third quarter.
In our fixed-income allocation, exposure to intermediate-term corporate bonds contributed the most to performance, while our core bond allocation contributed the least to performance.
Market Outlook
In our recent writings, we have been flagging our cautious stance on equities and the two-way risks to bond yields despite the increases we have already seen this year. Recently, stock prices have moved lower, and bond yields broke out firmly to new highs, conjuring up flashbacks to the difficult market environment of the first nine months of last year that proved so challenging to traditional portfolio construction. We do not believe we are in for a repeat of last year, but we are keenly focused on stability in the bond market, especially in longer-term rates, as a precursor to improved equity sentiment. Third quarter earnings season, which is set to kick off soon, will provide a welcome change of potential catalysts from the macro-driven markets of late. And beyond the near-term gyrations, our core view of a more resilient U.S. economy, underpinned by an employed consumer less sensitive to interest rates than in past cycles, remains firmly intact. Very few investors enjoy the market volatility we have experienced of late. Yet, such volatility often unearths attractive opportunities that a disciplined investment process may be able to take advantage of. Against that backdrop and with Horizon’s innovative portfolio design and risk mitigation techniques, we seek to continue to help our clients navigate today’s uncertain landscape and plan for their financial goals in the years to come.
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. Individuals cannot invest directly in any index. Indices are unmanaged and do not have fees or expense charges, which would lower returns.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. 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.
© 2023 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
