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Quarterly Report Q3/2023

Review

We hope you had a pleasant vacation (or, if it is still ahead of you, a nice perspective) and have returned home relaxed, recovered and full of energy in good health.

This year, the summer saw ups and downs on the stock exchanges, ranging -- depending on the market -- between five and ten percent. As we expected, volatility increased without causing either a clear breakout into new spheres or a strong reaction in a southerly direction.

In line with our expectations, the central banks in Europe and the USA were unable to keep their hands off the interest rate screw and once again turned the wheel upward. The ECB raised the main refinancing rate twice by ¼ percentage point each to 4.50% and the deposit rate to 4.00%, thus reaching a record level since the introduction of the euro with its tenth interest rate hike in a row. In America, the FED also raised the key interest rate by a further ¼ percentage point and now has a range of 5.25-5.50%, the highest level in 22 years.

Dark clouds were gathering on the real estate markets. Across Europe, the upward price spiral came to an abrupt end. Massively higher interest rates took full effect and led to a slump in the turnover of existing properties. In addition, higher construction costs pushed the number of new construction starts down significantly. The overall situation was exacerbated by the bankruptcies of small but also well-known and major project developers. As a result of these developments, the vast majority of real estate stocks suffered severe price losses at times.

Performance

Our equity fund shows a performance of +6.90% in Euro and +4.73% in Swiss Francs since the beginning of the year. This compares to the major indices: DAX +8.26%, STOXX600 (Europe) +7.02%, S&P500 (USA) +12.15% and MSCI World (global) +10.67% (all values in CHF). Our hedges over the last months have cost some performance, but they are and remain a central part of our strategy. Ultimately, the gains in the US in particular are not due to the broad market, but to just a few technology stocks -- not a particularly solid foundation.

The performance of our bond fund at the end of the quarter was +0.84% for the CHF tranche and +0.76% for the EUR tranche. We expect things to calm down on the interest rate front by the end of the year, which should have a positive impact on further performance. The picture is still dominated by mispricing in the market, but it is only a matter of time before normalization sets in and price levels start to move upwards again.

Current positioning

Similar to the second quarter, the third quarter was characterized by constant upward and downward movements. While interest rates in Europe and the U.S.A. are generally rising and this is depressing sentiment on the stock markets, the relatively good economic data and solid corporate results are preventing major losses in equities. As a result, neither equity markets nor sectors nor most individual stocks are breaking out of the sideways movement that has persisted since the spring.

Over the summer months, we did comparatively few transactions. In the first half of the quarter, we selectively built up positions in financial, industrial and pharmaceutical companies. From the end of August, we realized short-term gains in selected financial, technology and energy stocks, which slightly increased our cash reserves. In the case of some stocks currently suffering from the uncertain economic situation, we are waiting for more attractive entry points and plan to buy in as soon as the interest rate situation stabilizes somewhat.

The positions in our bond fund also remained largely unchanged. The scene is still dominated by distortions in many bonds, especially financials, with the result that many securities are trading well below 100. Visually, this is very unattractive, but it remains important to keep calm and keep your nerve. Several times in the past, the markets went through similar phases and then benefited all the more from recovery movements. We are skeptical about investing in longer-dated bonds due to, first, the inverse yield curve and, second, higher liquidity and lower interest rate sensitivity in short-dated bonds. Where possible, we roll to a higher interest rate or, in the case of floaters, benefit from higher coupons anyway. The interest payments, which form the basis for next spring’s distribution, have been running as planned to date, so we are ideally positioned to be able to deliver a very attractive distribution yield again in 2024.

Outlook

…remember to come back in September. This is an old stock market rule that commonly advises selling stocks in May in order to reinvest the liquidity then created and available after the summer. Those who followed this rule in the spring have not really earned this year, depending on the market. The SMI in Switzerland only fell slightly, the DAX mainly ran sideways, and in the United States of America one might even have lost returns. Will the economy manage a soft landing (i.e. only a slight recession) or will we end up with a deeper recession at the end of the day? The markets are still successfully ignoring a negative scenario and are thus becoming a “pain in the neck” for every stock investor who did not allow himself to be pulled along at the beginning of the year or even let himself be carried away into selling.

Even though various macro data can now cause worry lines to appear on the forehead, the generally cautious mood has not had a sustained negative impact on corporate results, at least not so far. However, we are well aware that the effects of the central banks’ interest rate moves may only be felt with a time lag. This makes quality in the portfolio all the more important, because investments with substance do not necessarily appear sexy in the short term, but they provide an enormous degree of stability, security and consistency. For this reason, we are focusing even more than usual on companies with low levels of debt, as these are significantly less affected by the rise in interest rates than highly indebted “high flyers”, such as those usually found in the high-tech sector.

There is great uncertainty in the real estate market. The run on owning property, triggered by the euro crisis at the beginning of the last decade, can be used as an excellent example of the normative power of the factual. Now, however, owners are experiencing how quickly repressive government measures can be introduced and make ownership more expensive. The new heating law of the “traffic light” government in Germany caused irritation and annoyance in equal measure, and the issue of property tax continues to smolder in the background. As an owner, one sees oneself at the mercy of the state to a certain extent; after all, at the end of the day, no one can just tuck their apartment or house under their arm and thus migrate to another state.

Interest rates have virtually exploded in the past 12 months, bursting the dream of owning a home like a soap bubble for many prospective buyers because the annuity for the required loan amount is simply no longer feasible. So it is now no longer a question of whether you want to buy a property, it is rather a question of whether you can afford it at all. For existing financing, some property owners will have to think about extending their expiring loans. Numerous banks have already expanded their risk provisions, as they apparently expect defaults on the loan side in the near future.

The rising vacancy rates in the commercial real estate sector underscore the current tense situation, even in metropolitan areas such as Berlin, Frankfurt and Munich, which for years were among the cities with the greatest demand and the highest rents. Particularly in the case of retail space, the negative trend triggered by Corona and the resulting increase in online shopping continues unabated. The trend for office properties does not look quite so negative, but it does not take a rocket scientist’s certificate to realize that home offices and artificial intelligence are unlikely to bring the demand for office space back up to pre-Corona levels.

In residential real estate, there is a rarely seen imbalance between high supply and low demand. It will take time for a healthy balance to be achieved here and for prices to start rising again. However, this will require the central banks to lower interest rates. Given the inflation rate of 4.5% in Germany in September, this is quite conceivable.

The bond markets are still reeling from the turmoil caused by the banking crisis in the spring (Silicon Valley Bank, Credit Suisse). One look at the bonds of most financial stocks is enough to see how pronounced the crisis of confidence is. However, whenever such distortions in valuations, i.e. in bond prices, have been registered in the past, idiosyncratic opportunities have arisen precisely from this situation. On a positive note, the recent interest rate hikes by the ECB and FED have not negatively impacted the recovery movement of recent months. From this perspective, we continue to regard the risk-reward profile in the bond segment as very attractive in the medium term, especially since the higher interest rates are having a positive impact on bond coupons.

Conclusion: If you’re not invested on the way down, you’re not invested on the way up. The current market situation may have something lulling about it, but it does not block our view of the possibility of a rash of volatility. Our medium-term positive assessment for equities remains unchanged, yet we are sticking to our hedging strategy, which has proven itself throughout the crises of this millennium. So that you can sleep well even and especially when the waters become choppy. In the knowledge that we will look after your assets carefully and prudently.

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