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Cartesio October 2019 commentary

Fecha de publicación 07 de noviembre de 2019

Llevamos ocho años enviando un comentario mensual en inglés a los clientes institucionales que siguen nuestros fondos en Luxemburgo (réplicas de los domiciliados en España). Los clientes nos llevan diciendo tiempo que encuentran el comentario útil y, suponemos, algo más entretenido que el comentario de las fichas mensuales donde, por razones de espacio, el comentario es necesariamente más breve y menos elaborado. El inglés es el latín de nuestra época y en el mundo financiero es, a efectos prácticos, la lengua vehicular.

Cartesio September 2019 commentary

Cartesio October 2019 commentary

Dear Investor,

Pareturn Cartesio Income (PCI) is up 0.79% in October and up 2.93% YTD. Pareturn Cartesio Equity (PCE) is up 1.58% in October and up 6.31% YTD. Since inception (March 2004), Cartesio X (replicated by PCI) is up 86.8% (4.1% p.a.) with a volatility of 3.1%; Cartesio Y (replicated by PCE) is up 128.6% (5.45% p.a.) with a volatility of 9.5%.

Both funds have outperformed their benchmarks in risk adjusted terms since inception (March 2004). As always, we enclose the factsheets (October 2019) of both funds and a pdf file file showing the best and worst equity performers of the fund in the month.

Rotation, less uncertainty, rates dare to tick up, it is raining dogs, hallelujah!…

European equities inch towards a new high in October, rising by 0.59%. The news is not equities being in the rarified air of the stratosphere, yes European equities hit an all-time high in (on a total return basis) in October. The news is that the rotation into cyclicals/value sectors that started around August has continued and gathered some momentum. At the same time, long term interest rates had the temerity to inch upwards from the all-time low reached in early September (our reference index of long term eurozone government bonds is down 1.74% from its September high). Our short position in bund/bono (7% of the fund) made us some money, it is about time.

We believe the rotation into cyclicals/value is the result of two factors: a) The valuation and investor positioning in the growth/quality stocks had reached levels not seen since the peak of the TMT bubble. b) Uncertainty and fears over the economy have been reduced on the back of constructive developments around Brexit and trade wars.

We believe there may be a third factor at play. More dangerous, but not exempt from some logic. The attractiveness of equities versus bonds trading at zero yield has been evident for some time, with the gap between dividend yield and bond/credit yields at historical highs, and risk premium models justifying current valuations only by plugging in an 8% risk premium. We are not fans of justifying equities as an asset class on the back of interest rate-based valuation models, rates may be extraordinarily low for a very bad reason: long term growth prospects are dire and therefore the buy signal may be wrong. Yet as the consensus has capitulated on interest rates, seeing zero/negative rates as the new normal, the search for yield has reached manic proportions. We know from experience, we have seen our AT1s fly in the last five years, delivering a 44% return (well above European equities, government bonds and against a 15% correction in bank equities) with yields now well below bank equity yields. Remember an AT1 is a perpetual bond where you can we wiped out easily if a bank´s capital cushion is under pressure, not impossible in the highly leveraged construct that a bank essentially is.

In the search for yield/returns and duration investors, private and institutional, have increased allocation to alternative/private equity investments where mark-to-model rules and which, in the case of insurance companies and pension funds, are not as badly treated from a regulatory point of view. We are seeing deal valuations in the private equity and M&A space at a large premium to the valuations we see in public equities. We think that a generational investor like a sovereign fund/family office, who can take a long-term view and ride out the volatility, can exploit this valuation gap by selling zero yielding bonds and buying high real yields in public equities. Indeed, they may be doing it: equities are making new highs with investors selling equity mutual funds and net hedge fund exposure also at very low levels. We would add that when looking at dividend and free cash flow yields, it is the value/cyclical sectors which really stand out against their historical and the market average.

Be what it may and last what it lasts, perky equity markets and a rotation into cyclical/value stocks is what we have been positioning for since the fourth quarter of last year. It has not been an easy ride, with our equity portfolio underperforming significantly at times and the overarching consensus being play defensive, buy quality and stay away from the cycle. In the last few months, the strategy is delivering and has allowed us to offer attractive absolute and relative returns in both funds which have reached new highs. YTD our equity portfolio is up 15.4% against the market´s 20.4%, a gap that was nearly double at the end of June. It has been raining dogs recently and we are hardly complaining.

Our sense is that the rotation into value/growth has further to go but we are unlikely to increase equity exposure further from current levels. We have wind in our sails and our intention is to maintain risk exposures into the year-end albeit trimming and managing our portfolio actively. In the PCI fund, we have a rump of mostly AT1s left from a huge bull market in rates and credit. Exposure has been sharply reduced during the last twelve months and we are inclined to switch into equities further at the right price.

Madrid 31th October 2019