This year’s punishing price action across markets continued last quarter as global stocks (MSCI ACWI Index), and core bonds (Bloomberg U.S. Aggregate Index) fell for the third consecutive quarter. As has been the norm throughout 2022, volatility was elevated across equities as an early rally gave way to a sharp sell-off mid-quarter. Divergences in the quarter were wide at the allocation level, with notable outperformance of U.S. large-caps (S&P 500 Index) versus internationals (MSCI ACWI ex-U.S. Index). At the same time, style and factor performance within the domestic equity market was more muted. Horizon’s accumulation models maintained a full equity allocation throughout the quarter but did so with a defensive stance for the third straight quarter.
In our Gain equity allocation, we began the quarter with a substantial overweight to domestic stocks. We were also strongly tilted toward value exposure and defensive sectors while maintaining a sizable allocation to the more domestically oriented small- and mid- cap market segments. As the quarter progressed, we increased our smaller-cap bias while trimming our value overweight as volatility within the growth-value split rose. Internationally, we maintained our large underweight to Europe throughout the quarter. In line with our expectations, our equity allocation generally exhibited defensive properties versus broad passive equity benchmarks throughout the third quarter.
The fixed income market was also extremely volatile throughout the quarter as investors grappled with the outlook for central bank policy. After falling initially, U.S. Treasury yields rose to new cycle highs while maintaining their persistent flattening trend throughout the quarter. Credit spreads broadly followed the same trend as core rates, tightening to start the quarter and then widening as equity losses mounted from mid-August onward. Given this volatility, our fixed income allocation decisions were relatively muted throughout the quarter. We began the third quarter positioned defensively in terms of sector exposures and shorter duration than the benchmark, as well as underweight mortgage-backed securities. As the quarter progressed, we slightly increased risk in the portfolio by adding duration (though we are still underweight) and increasing investment-grade credit exposure.
Gain Equity Contributors and Detractors
The most significant contributors to the performance of the Gain equity portfolio in the third quarter were domestic large-cap value, domestic equal weight factor exposure, and domestic energy. Domestic large-cap exposures to growth, quality, and quality dividends contributed the least to returns.
Gain Fixed-Income Contributors and Detractors
In the fixed-income portfolio, as has been the case all year, interest rate sensitivity drove returns in the third quarter. Short-term U.S. Treasuries, short-term investment grade corporate debt, and a core tactical bond holding contributed the most to performance last quarter. Long-term U.S. Treasuries, long-term investment-grade corporate debt, and a separate tactical core bond holding contributed the least to performance.
Horizon’s Protect portfolios began the third quarter with sizable de-risked allocations to short-term U.S. government debt. Due to the volatile nature of markets in the third quarter and the magnitude of the pullback in asset prices, there was considerable activity from the Risk Assist® algorithm across the Protect suite. At the end of the quarter, market and portfolio losses had deepened, and all Protect strategies had larger de-risked allocations than at the start of the quarter. The Risk Assist activity mitigated some of the drawdowns across markets in the third quarter while also lowering overall portfolio volatility, in line with our expectations.
Due to the sizable engagement of the Risk Assist algorithm during the quarter, the underlying allocations across equities and fixed income played a smaller role in overall portfolio performance than usual. After Risk Assist had meaningfully de-risked the Protect portfolios in the second quarter of this year, we reallocated our equity portfolio seeking to improve its ability to participate in a market reversal if it happened. That reallocation included an overweight to domestic growth and small- and mid- caps, as well as a more balanced allocation to international equities than in our Gain portfolios. We maintained this positioning in our underlying equity portfolio throughout the third quarter. The fixed income portion of our Protect portfolios was positioned with the same defensive stance we exhibited in our Gain portfolios. We slightly increased fixed income risk during the quarter, trimming our duration underweight and adding investment-grade corporate credit exposure.
Protect equity contributors and detractors
Given the above reallocation in our equity portfolio after Risk Assist engagement meaningfully picked up, the attribution of our Protect and Gain equity allocations diverged in the third quarter. Domestic mega-cap technology, domestic quality factor exposure, and domestic ESG exposure contributed the most to performance. Emerging markets, domestic large-cap value, and international developed markets contributed the least to returns in the third quarter.
Protect Fixed-Income Contributors and Detractors
In the fixed-income portfolio, interest rate sensitivity was again the main driver of returns as interest rates rose throughout the quarter. Short-term U.S. Treasuries, short-term investment-grade corporate debt, and a core tactical bond holding contributed the most to performance last quarter. Contributing least to performance in the third quarter were long-term U.S. Treasuries, long-term investment-grade corporate debt, and a separate tactical core bond holding.
It was another challenging quarter for markets as volatility and uncertainty ultimately led to the third consecutive quarter of losses for global equities and core bonds. Horizon’s Spend portfolios began the quarter partially de-risked due to prior Risk Assist activity. As market losses deepened, de-risking activity increased in the Spend portfolios, although this activity was generally more muted than in comparable Protect portfolios due to differences in portfolio construction and Risk Assist calibration. For the third straight quarter, the Spend portfolios did not replenish their spending reserves, in line with the design of our intelligent rebalance program. This year is an example of the benefit of maintaining a liquid reserve to fund current spending while not foregoing a potential recovery in the investment portion as part of a retirement spending solution.
Spend Portfolio Positioning
The core allocation decision of the Spend portfolios, featuring a tilt away from core bonds and toward equity markets, was not beneficial in the third quarter as global equities (MSCI ACWI Index) underperformed core bonds (Bloomberg U.S. Aggregate Index). However, the de-risking activity of the Risk Assist algorithm and the allocation to cash and short-term U.S. Treasuries in the spending reserve buffeted some of that core tilt last quarter. Our underlying allocation changes were modest in the third quarter. As noted above, the lack of spending reserve replenishment as part of our regular rebalance process resulted in a slightly increased allocation to the investment portion of the models.
Spend Contributors and Detractors
In the equity allocation of the Spend portfolios, exposures to small-cap domestic low-volatility, domestic mid-caps, and international low-volatility stocks contributed the most to returns last quarter. Core holdings across domestic large-caps, domestic large-cap value, and international developed markets contributed the least in the third quarter. In our fixed-income allocation, exposure to high-yield corporate bonds contributed the most to performance, while our core bond exposure lagged.
Throughout the first three quarters of 2022, investors have experienced difficult conditions for both stocks and bonds, and many are hoping that the fourth quarter will offer some respite. That hope continues to look misplaced in our view. Despite the rapid increases in interest rates so far this year, we think central bankers will continue to advance restrictive policies to combat multi-decade highs in inflation, keeping asset market volatility elevated. On the fundamental side, corporate earnings season will provide an update on how companies are navigating a clearly-slowing economic environment; the tradeoff between pricing and volumes is of particular interest to us this quarter. Our overall cautious near-term view continues to inform our conservative positioning, but we are taking note of the compression in asset valuations across equities and fixed income. Lower valuations should improve returns once today’s inflationary storm has passed. The investment team at Horizon is watching for this turning point and seeking out opportunities amidst the elevated volatility.
Past performance is not indicative of future results. The investments recommended by Horizon are not guaranteed. There can be economic times when all investments are unfavorable and depreciate in value. Clients may lose money. This information should not be considered to be a recommendation to buy or sell any security or to adopt a particular investment strategy. It should not be assumed that any of the transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Opinions referenced are as of the date of publication and may not necessarily come to pass. Forward looking statements cannot be guaranteed. We do not intend and will not endeavor to provide notice if and when our opinions or actions change. References to indices, or other measures of relative market performance over a specified period of time are provided for informational purposes only. Reference to an index does not imply that the any account will achieve returns, volatility or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change.
RiskAssist® is NOT A GUARANTEE against loss or declines in the value of a portfolio; it is an investment strategy that supplements a more traditional strategy by periodically modifying exposure to fixed income securities based on Horizon’s view of market conditions. While Risk Assist was designed with the goal of limiting drawdown, Horizon is not able to predict all market conditions and ensure that Risk Assist will always limit drawdown as designed. Accounts with Risk Assist® are not fully protected against all loss. Furthermore, when Risk Assist® is deployed (whether partially or entirely) to mitigate risk for an account, the account will not be fully invested in its original strategy, and accordingly during periods of strong market growth the account may underperform accounts that do not have the Risk Assist® feature.
The Real Spend® retirement income strategy is NOT A GUARANTEE against market loss and there is no guarantee that the Real Spend® strategy chosen by an investor will lead to successful investment outcomes for part of, or for the entirety of an investor’s retirement. This strategy is not an insurance product with payments guaranteed. It is a strategy that invests in marketable securities, any of which will fluctuate in value. Before investing, consider the investment objectives, risks, charges, and expenses of the strategy. Keep in mind investing involves risk. The value of an investment will fluctuate over time and will gain or lose money.
Horizon Investments, the Horizon H, Gain Protect Spend, Risk Assist and Real Spend are all registered trademarks of Horizon Investments, LLC.
© 2022 Horizon Investments, LLC.
NOT A DEPOSIT | NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
NOT GUARANTEED | CLIENTS MAY LOSE MONEY | PAST PERFORMANCE NOT INDICATIVE OF FUTURE RESULTS