2022 1st Quarter Client Letter
By Will Klein, CFA
Quarterly Investment Commentary
Over this last quarter, investors contended with higher inflation, tighter financial conditions, and a geopolitical crisis in Europe. Consumer Price Index (CPI) inflation climbed from 7% in December to an estimated 8% in March. The Fed responded to stubbornly high inflation by hiking interest rates for the first time since 2018. Russia’s invasion of Ukraine compounded those macro challenges as retaliatory sanctions against Russia stressed already tight commodity markets, pushing prices for oil, wheat, and other Russian exports to multi year highs.
Those cross currents buffeted markets over the quarter. Bond markets sold off, as ten-year treasury yields climbed from 1.5% to 2.3%. US equities came under pressure, as the S&P 500 returned -5%, while the growth-skewed NASDAQ Composite Index returned -9%. International equity markets similarly struggled, with the MSCI All Country World Ex US Index returning -6% in dollar terms.
Throughout those volatile markets, we have stuck with our strategic asset allocation framework. That approach helped shelter clients from some of those market headwinds. For instance, our shorter duration bond focus insulated clients’ fixed income allocations from extreme inflation and interest rate volatility. Meanwhile, our focus on domestic equities left clients less exposed to geopolitical and commodity market shocks. However, our approach favoring high quality growth companies within equity portfolios was not well-rewarded over the quarter.
Investments in growing businesses like Microsoft, Costco and Visa have been key drivers of clients’ long-term returns. Nevertheless, those faster growing companies have fallen out of favor recently, as markets have rotated into value stocks. Over these last couple years, we’ve added to cyclical equities and inflation beneficiaries to manage that risk. However, we’re maintaining our core focus on high quality businesses with growing end markets. We believe that approach, owning great businesses at good prices, will continue to drive long-term returns.
Our growth and quality focused approach to equity markets could become increasingly key as the “new normal” of slow and stable growth, modest inflation, and long business cycles, which investors have experienced over the last 20 years, gives way to a more volatile economic environment. Fast growth, hot inflation, and macroeconomic uncertainty underscore the need for strategic thinking and a focus on long term return drivers.
Through all of this, we remain focused on investing in environmental, social and governance (ESG) leaders. We have seen strategists frame rising energy prices, climbing interest rates, and hot inflation as cause for an “identity crisis” among ESG investors. While the recent rotation into value stocks and energy stocks has been a headwind for some ESG strategies, we believe claims that those cyclical headwinds undermine the strategic case for ESG integration are misguided and short sighted.
Today’s tight labor markets and high energy prices should ultimately strengthen the competitive positions of companies which have been proactive about treating employees like stakeholders and investing in energy efficiency. Moreover, recent energy market challenges could accelerate demand for clean energy investments. Portfolio companies like NextEra, the leading wind and solar power generator, could be key beneficiaries of those trends so, we believe, ESG integration will continue to be a natural complement to our long-term quality-oriented philosophy.
We will continue to take a disciplined, diversified approach to managing your portfolios; This informs our asset allocation framework, where we are staying the course through today’s stormy seas. It also drives our equity market strategy, where we continue to invest in high quality businesses and ESG leaders with attractive long term growth prospects. Lastly, it factors into our manager selection framework, where we are partnering with groups which share our strategic approach. We remain focused on building portfolios to help you achieve your long-term goals. Please do not hesitate to reach out if you have any questions.