2020: Management Report (Jan 4, 2021) English version

2020 was dominated by the evolution of the pandemic from Covid-19, an unprecedented event in the years after the Second World War (75 million people infected and 1.7 deaths in Europe and the United States, much more affected than Asia) which upset the countries on the social and economic level by, among other things, making the criteria adopted so far to read reality and make predictions rather unsuitable for the task.


The first wave of the virus, between March and May, plunged financial markets into a crash worse than that of 1929 that triggered panic on a global scale. Fortunately, it has been addressed appropriately thanks to the joint action of central banks and governments (It was helpful that many of the current leaders of political institutions witnessed the many mistakes made during the great financial crisis of 2008).


The year began already with signs of a slowdown in economic fundamentals (manifested before the threat of Covid-19 took shape) and with significant tensions over the availability of dollars in the credit market (especially in the EM with substantial USD denominated debt). The Federal Reserve intervened by creating almost unlimited swap lines with foreign countries, preparing to further expand the balance sheet (as it had already done significantly from September to December 2019).


Despite deteriorating fundamentals, the S&P 500 reached new heights in January: numerical evidence and investor exuberance are typical of the later stages of the business cycle.


Until the end of February, markets seemed mainly driven by the Fed and, to some extent, by the continuing boom in passive investment (see the Climate Change newsletter of January 26). To these, it seems, have been added the strategies in bullish options positioning from new retail platforms such as Robin Hood. However, the pandemic caused a sudden reversal of the trend. The markets were then pushed violently downwards by the unwinding of these strategies in particular by those limited in the level of risk (for example those at risk parity). One of the most dangerous sell-offs in the history of the markets has been triggered.


On February 20, the portfolio was re-balanced several times to adapt to an acceleration of the economic crisis while retaining some exposure to quality equities and bonds which, however, given the severity of the crisis, were temporarily dragged to new lows up (see the newsletter He is a bear: we know him and we know how to deal with him of March 13).


In the face of the health crisis, governments have not made the same mistakes as in 2007/8 when massive stimulus by central banks were slow to come and uncoordinated and the austerity line prevailed in many cases. This time, the European institutions have moved decisively by planning the recovery through a fund to be launched as quickly as possible and by clearing the concept of supranational public debt in Europe. The affirmation of this line was certainly facilitated by the German presence in the key positions of the European institutions: Ursula von der Leyen, President of the European Commission; Klaus Regling, Managing Director of the European Stability Mechanism; Werner Hoyer, President of the European Investment Bank; Klaus-Heiner Lehne, President of the European Court of Auditors.


In mid-March, the markets hit the bottom, recovering some stability but with uncertain prospects. The bearish signals continued at least until the end of June and the comparison with events of similar magnitude in the past justified the concerns: in 70% of cases, the rally following the achievement of the lows was followed by new lows (see newsletter Markets close to the minimum, but beware of the new tests on 23 March). We, therefore, preferred a very safe portfolio pending a more precise assessment of the damage to the economy caused by the pandemic. Contrary to expectations, the market rebound was rather strong, resulting in a temporary underperformance of the fund.


In those weeks, Neokeynesian visions such as Modern Monetary Theory sank the winning blow by making their voices heard within Fed policy (see newsletter The (epochal?) Turn in monetary policy forces us to change the prospects of March 29).


Whatever the theoretical references behind its action, the Fed reacted promptly to the economic threat of Covid-19 and, without waiting for the canonical meetings of the Federal Open Market Committee, increased the budget by almost 50% between the March 13 (inactivity until that day showed how quickly the market can collapse) and June 12. At the same time, Congress approved the necessary tax measures to support businesses and households.


A side effect of the surprising productivity of the institutions of the European Union has been the consolidation of the central role of the Euro, should a confirmation still be necessary after the now-famous whatever it takes by Mario Draghi in 2012 (see the newsletter https://it.simplifypartners.com/post/the-bearable-lightness-of-the-euro). Eurosceptics were silenced when the principle of a supranational debt was shared to restore the stability of the European economy: in a world with interest rates close to zero, the difference between debt and money is, in fact, blurred, hence a further, implicit guarantee for the stability of the Euro.


With central banks buying bonds on a regular basis, the line between fiscal and monetary policy becomes indistinguishable. Even in Europe, where in the past everything has been done to keep the distinction clear, the ECB's Quantitative Easing effectively mutualises the debt: a liability common to all (the currency) is exchanged for a fungible asset (the bonds of individual states). Political-institutional creativity does not make the Euro an impregnable fortress, but it certainly leads to considering it in a new light.


In May, the situation was still considered unstable and with uncertain prospects. While central banks, the US federal government and that of the European Union were moving rapidly (mindful of what happened in the great financial crisis of 2007-2008), individual states and companies were still in the damage assessment phase. Markets were thus driven by monetary momentum rather than by visibility into future earnings and cash flows generated by companies.


At this stage, the Simplify 02 portfolio was structured as follows:

It became clear at that time that markets needed strong guidance before returning to growth after the March downturn and that some sectors of the economy had grown more than was justified or at least expected (for example, technologies for home working, products for home and personal hygiene, hospital equipment). In that period there was an increase in implied volatility, a sign that investors were no longer certain of a repetition of the bullish trends of the past years or in any case were willing to pay more for protection (or to sell it). We considered that any portfolio weighting should take into account these variables and uncertain correlations.


Another key point: the markets seemed destined to be driven by a growing acceleration linked to the expectation of a return to normal profits. In some sectors (for example those related to home renovation) this expectation seemed founded on solid foundations, in others, it seemed less well-founded.


In any case, in August, the level reached by several fundamental indicators led to consider many valuations rather tight and the majority of investors, including Simplify 02, kept a large part of the portfolio in risk-free assets.


The July-August rally, therefore, came unexpectedly and can be justified, in retrospect, more than with fundamentals, with the probable modification of the Fed's mandate and therefore the possibility of expansionary monetary measures (see the newsletter The Fed prepares a more elastic policy of 27 August).


The catalyst for the recovery finally came on November 9 when Pfizer announced the positive result of the vaccine tests (90% efficacy). From that moment on, the Simplify 02 portfolio was directed almost to the maximum risk limit, following the right expectations that normality could return even in the economic sectors lagging behind.


Once incorporated into most evaluations, the "vaccine effect" wore off and the portfolio was placed in safe mode until the end of the year.


The performance for 2020 stands at 3.82% with a volatility of 1.69. The reference benchmark on Bloomberg (Bloomberg Discretionary Macro Hedge Fund Index) reports + 6.5% but with a standard deviation of 36.72. Simplify 02, per unit of risk, performed approximately 13 times the basket of comparable strategies (2.26% vs 0.17% per unit of risk).


Best wishes and best wishes for a good 2021


Federico Polese


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Simplify is an AIF umbrella fund, is authorised by CSSF in Luxembourg and passported in Italy and Sweden. The fund is managed in London.