Portfolio Managers comments
During June, the weak and volatile development that has been a fact during the first half of 2022 continued. Investors’ focus shifted between concerns about high inflation and rising interest rates and risk for recession as a consequence of excessive monetary tightening by central banks. During the month, new shutdowns were imposed in a number of Chinese cities as a result of local Covid outbreaks, which created concerns that China’s zero tolerance policy will delay the economic recovery. After taking control of large areas in eastern Ukraine, Russia resumed their attacks on Kyiv, which may be a response to Ukraine being granted candidate status to the EU.
Russia missed an interest payment on US dollar bond, which means that the country is now officially in default for the first time since 1918. The reason why Russia cannot pay is that they can only offer payment in Rubles due to the restrictions and the event is not expected to have any major practical consequences. After extensive diplomatic negotiations which included a meeting where Magdalena Andersson together with Finnish President Niinistö met Turkish President Erdogan, the countries reached an agreement which means that Sweden and Finland are now getting closer to membership in NATO.
After high inflation figures for May were published, the US Federal Reserve chose to raise its policy rate by 75 basis points. The decision was anticipated and market reactions were limited. According to the Fed, it is still possible to achieve a soft landing for the US economy, but in a later speech, the head of the Fed, Jerome Powell, emphasized that fighting inflation is the main goal and that it can be difficult to avoid a recession. The ECB did not change its policy rate in connection with its interest rate meeting, but prepared the market for a 0.50 percentage point hike at its July meeting. At the same time, recent market developments have led to rising interest rate differences between euro area countries, prompting the ECB to hold an extra meeting to discuss the situation and they are evaluating a new bond buying program with the purpose to reduce market turbulence.
In Sweden, the Riksbank raised the rate by 50 basis points to 0.75 per cent, at the same time as they communicated that they expect the policy rate to be around 2 per cent at year end. All major central banks, with the exception of Bank of Japan, are now in an phase where they are rising their rates. The expectations are that interest rates will rise sharply for a limited period of time and that the peak of hiking cycle will be reached within the next year. Thereafter, the perception is that the effects of high inflation and higher rates will lead to lower growth and gradually lower price pressures.
The credit market had a very weak development and bond prices fell substantially in both the Nordic and international credit markets. Credit spreads are at historically high levels, which creates challenges for companies that are considering to issue new bonds and the primary market activity has declined as a result. The real estate company SBB was in the spotlight again after Viceroy Research published a new report in which they questioned SBB’s cash flow and accused the company of not reporting all its debt on its balance sheet. However, after a number of meetings with investors, interviews in the media and clarifications in press releases, the company was able to show that no formal errors had been committed. Despite the information from the company, the company’s bonds traded down sharply and it is clear that the company needs to improve its communication with the market. The news flow in another of the large real estate companies, Balder, was also negative after a number of people with connections to the company, including the Head of Finance, were convicted of insider trading in the niche bank Collector, in which Balder is a large owner.
The entire real estate sector is currently under pressure in the bond market as investors worry about the effects that rising interest rates will have on companies’ earnings and asset values. However, as most companies have longer maturity and duration profiles in the loan portfolios, it will take time before the higher borrowing costs have full effect. It will probably take some time before the financial market development affects property valuations, which means that property values will not fall as quickly and as much as the market seems to be expecting right now. Nordic Capital made a comeback as owners of Ellos when they took over the company from the previous owners, Dutch FNG, which initiated insolvency proceedings during spring. We deem it as positive that Ellos gets a new owner with the ability to support them financially in their continued operations.
All funds had a weak performance during the month as a result of the rising credit spreads. Simplicity Likviditet decreased by 0.32% while Simplicity Företagsobligationer, Simplicity Global Corporate Bond and Simplicity High Yield decreased by 3.04%, 3.74% and 3.73% respectively. Yields have continued to rise and is now at historically high levels in all funds.
Performance YTD: -0.81%
Duration: 0.21 years
Maturity profile: 1.09 years
Performance YTD: -6.48 %
Duration: 0.79 years
Maturity profile: 3.31 years
Simplicity Global Corporate Bond
Performance YTD: -8.94%
Duration: 1.80 years
Maturity profile: 3.03 years
Simplicity High Yield
Performance YTD: -7.16%
Duration: 0.99 years
Maturity profile: 3.12 years
Management comments – June 2022
The stock market slide continued during June and there were big swings in the markets that often opened strong but ended clearly down and vice versa. Investors find it difficult to agree on a level amid a new market climate with rising borrowing costs and weaker economic conditions.
Pleasingly, Simplicity’s home market funds Simplicity Norden, Simplicity Sverige and Simplicity Småbolag Sverige withstood the decline well. The latter fell by only 8.3% while the fund’s index fell 14.4%. The strategy of buying stable and profitable companies has paid off as the stock market valued down growth companies and highly leveraged companies. In addition to positive contributions from Axfood, SOBI and Biogaia, Simplicity Småbolag Sverige benefited from being highly selective in the industrial sector, where Loomis, Studsvik and Stolt-Nielsen all developed positively.
Similar holdings were behind good relative developments for Simplicity Norden and Simplicity Sverige, where AstraZeneca, Pfizer, Sampo, Orion, Orkla, Grieg Seafood and Essity also developed steadily. Even Akelius rose and stood out as an exception in a sour real estate sector grappling with rising financing costs and skepticism about valuations on balance sheets. The sector’s fall meant that Simplicity Fastigheter had a gloomy development during the month, although the fund beat its benchmark index by about 2 percentage points.
Both of our global funds, Simplicity Småbolag Global and Simplicity Green Impact, developed alright despite the fact that both funds were negatively affected by overweight in the materials sector that fell along with commodity prices. For Simplicity Green Impact, Boralex, a Canadian renewable energy producer, rose after New York selected the company to develop five new solar farms in the state. In Simplicity Småbolag Global, Sanderson Farms, an American chicken farmer and one of the fund’s largest holdings, rose 10% after progress in a consortium’s acquisition of the company.
Stock of the Month
During the month, Midsummer was celebrated in Sweden and this includes some fundamental ingredients such as herring. Several thousand tons of herring are eaten only during the midsummer weekend and most often it says Abba on the jar. Abba is a venerable Swedish company that is now owned by Norwegian Orkla, one of the holdings in Simplicity Norden. If the herring does not tickle the taste buds, the company’s product range is complemented by popular Kalle’s caviar and soy products from Anamma. Thirst is quenched, for example, with juice from Bob or Fun Light, which is also owned by Orkla. If the accident occurs, first aid from Cederroths or plasters from Salvequick bring relief. When the craving for coffee arrives, Orkla offers Gothenburg biscuits such as Ballerina and Singoalla as well as Frödinge cheesecake with jam from Önos. Towards the evening, chips from OLW arrive together with the mosquitoes and then Orkla offers its Jungle Oil. Before bedtime, we brush our teeth with a toothbrush and toothpaste from Jordan and when we wake up on Midsummer’s Day, in some cases Samarin may be needed before breakfast is served, then with bread baked with Kronjäst and with marmalade from Den gamle fabrik.
Orkla’s breadth of market-leading brands is surprisingly large and the company operates in market areas with very stable demand. Stability is a big reason for our liking of Orkla, but the valuation and dividend yield are also attractive.
The outside world in brief
The effects of inflation were also noticeable in June, as the central banks continued to tighten. In the U.S., the Fed raised interest rates by a whopping 75 basis points, signaling that a similar hike is to be expected at the next meeting. The increase was in line with expectations, which had been revised up from the beginning of the month until the announcement. The Riksbank followed suit with a 50 basis point hike, also as expected.
The new economic situation with higher cost of capital has brought with it a gloomier outlook for economic growth, something that is increasingly cited as the underlying reason for declining stock market days. Pessimism is also noticeable among private individuals in different ways. For example, retail sales in the US fell in May versus the month before and in Sweden the National Institute of Economic Research’s confidence indicator for households fell to a lower level than during the financial crisis. Perhaps the mood change is not so strange considering that the housing market has also begun to tremble in, among other places, Sweden. In many cases, Swedes have earned more from owning their home than from their profession in recent years, which is now less likely for future years. Weak consolation comes from the fact that at least commodity prices fell during the month as the price of coffee remains at a high level.
All of Simplicity’s equity funds developed negatively, with Simplicity Småbolag Sverige down by 8.3% while Simplicity Norden and Simplicity Sweden declined by 5.3% and 7.7% respectively. Simplicity Fastigheter was down 24.3% while Simplicity Småbolag Global and Simplicity Green Impact ended the month with a decline of 5.6% and 4.2% respectively.
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