The final quarter of what has been a difficult year for asset owners finished on a positive note as both global stocks (MSCI ACWI Index) and core bonds (Bloomberg U.S. Aggregate Bond Index) rallied, ending what had been three straight quarters of losses for each. Despite the rally across stock and bond markets, volatility remained elevated as investors grappled with slowing inflation, uncertainty around Federal Reserve policy, geopolitical and energy developments in Europe, and an abrupt change of Covid policy in China. These factors contributed to relative performance across equity styles and regions in the fourth quarter. The domestic large-cap growth segment (S&P 500 Growth Index) continued its bout of underperformance, whereas international stocks (MSCI ACWI ex-U.S. Index) reversed their prior weakness to strongly outperform U.S. large-caps (S&P 500 Index). Throughout the quarter, Horizon’s accumulation models maintained a full equity allocation, but remained allocated toward the parts of the global equity market that displayed defensive properties during 2022.
In our Gain equity allocation, we began the quarter tilted heavily toward domestic stocks, a stance we maintained throughout the quarter. Within the domestic portion of our portfolio, we favored value and defensive sectors, as well as higher-quality small- and mid- cap market segments. Internationally, our European and emerging market underweights were notable. We adjusted our positioning once during the quarter, slightly decreasing domestic growth exposure in favor of momentum factor exposure, a market segment that has recently displayed defensive characteristics. As the quarter progressed, the relative volatility of domestic versus international stocks increased, increasing the Gain portfolios’ beta during the period.
Elevated volatility, higher core interest rates, difficult liquidity, and pressure on credit spreads were the themes of the fixed income market in 2022. However, the fourth quarter saw a break in some of these trends, especially as it relates to long-term interest rates and corporate credit spreads, which headed lower, not higher, as we closed out the year. Volatility remained high and liquidity challenged, however, signaling to us that it is too soon to sound the all-clear. Horizon’s fixed income allocation was positioned defensively in the fourth quarter, favoring U.S. Treasuries and shorter duration exposures. We responded to the improving conditions in the fixed income market by increasing our duration and bringing our mortgage-backed securities exposure to overweight, funded by a reduction in shorter-term Treasury allocations. On the credit side, we slightly increased our overall exposure, adding small positions within the high yield space for the first time since earlier this year.
Gain Equity Contributors and Detractors
The most significant contributors to the performance of the Gain equity portfolio in the fourth quarter were international dividends and domestic small- and mid- caps. Emerging markets, domestic large-cap growth, and domestic momentum factor exposure contributed the least to returns.
Gain Fixed-Income Contributors and Detractors
In the fixed-income portfolio, long-term investment grade corporate credit, a tactical core bond holding, and medium-term U.S. Treasuries contributed the most to performance last quarter. High yield corporate bond exposure, both broad and higher quality, as well as a separate tactical core bond strategy, contributed the least to performance.
Horizon’s Protect portfolios entered the final quarter of 2022 with substantial de-risked allocations to short-term U.S. government debt. Risk Assist® was active across the portfolios in the fourth quarter, as expected when volatility is elevated in the middle of a drawdown period. The choppy recovery of equity and fixed income markets drove more re-risks than de-risks, however, and all Protect models ended the quarter with greater equity allocations than they started. Last quarter’s Risk Assist® activity was in line with our expectations and acted to materially lower portfolio volatility.
The underlying equity and fixed income allocations in our Protect portfolios played a smaller than usual role in overall portfolio performance because of the engagement of the Risk Assist® algorithm. We began the quarter with an equity allocation designed to increase any potential upside market capture, slightly tilted toward growth stocks and with a more balanced allocation to international equities than our Gain portfolios. Midway through the quarter, given the lack of participation of growth stocks in the market recovery, we decreased our domestic growth allocation in favor of domestic large-cap value and quality exposures. The fixed income portion of the Protect portfolios entered the quarter with the same defensive, high-quality stance as in our Gain portfolios. As market conditions improved during the quarter, we increased our duration and spread positioning in both credit and mortgage-backed securities, funded by decreased exposure to the short end of the yield curve and U.S. government debt.
Protect equity contributors and detractors
The biggest contributors to performance in the equity portfolio last quarter were broad international developed markets, domestic large-cap value, and domestic small-caps. Domestic exposures to large-cap growth and ESG, as well as mega-cap technology, contributed the least to performance in the fourth quarter.
Protect Fixed-Income Contributors and Detractors
In the fixed-income portfolio, long-term investment grade corporate credit, a tactical core bond holding, and medium-term U.S. Treasuries contributed the most to performance last quarter. High-quality high yield corporate bonds, a separate tactical core bond strategy, and broad high yield corporate credit contributed the least to performance.
After three consecutive quarters of losses for global equities and core bonds, the rebound across markets in the final quarter of the year was a welcome development for Horizon’s Spend portfolios. Due to differences in portfolio construction and Risk Assist® calibration, our Spend portfolios began the fourth quarter less de-risked than our Protect portfolios. As would be expected, Risk Assist® was active throughout the quarter in our Spend portfolios as well, resulting in an increase in the allocation invested in the growth portion of the models by the end of the quarter. For the first time this year, performance across the Spend models in the fourth quarter allowed for a replenishment of the spending reserve. The Spend models began 2023 with ten quarters of target spend.
Spend Portfolio Positioning
The strong rebound in equity markets in the fourth quarter, both on an absolute basis and relative to broad bonds, was accretive to the core allocation design of the Spend portfolios. As expected when starting with a sizable de-risked allocation, Risk Assist® activity mitigated some of the benefit of this core tilt last quarter. Our underlying portfolio allocation changes were muted in the fourth quarter. As noted above, the spending reserve replenishment as part of our regular rebalance process resulted in a slightly decreased allocation to the investment portion of the models.
Spend Contributors and Detractors
In the equity allocation of the Spend portfolios, exposures to domestic large-cap value and broad international developed markets contributed the most to returns last quarter. Low volatility factor exposures to domestic small-caps and international developed markets contributed the least in the fourth quarter. In our fixed-income allocation, exposure to long-term investment grade corporate bonds contributed the most to performance, while our high yield corporate bond exposure lagged.
As we turn the page on a historic and difficult year for investors, it is helpful to reflect on what has changed recently and what remains the same. The reopening of the Chinese economy, which we expect to lend support to global growth and inflation in 2023, is the biggest new development, followed by a switch in focus by the Fed away from headline inflation and supply chains and towards the state of the labor market. Valuations are also more attractive across the capital markets, a long-term positive for investors. But our view that the Fed remains a single mandate central bank, firmly focused on eradicating inflation and not on supporting economic growth, remains unchanged, as does our assessment that volatility across the interest rate complex is still too high for comfort.
Synthesizing it all, the investment team is maintaining our conservative stance, favoring value and dividend stocks and higher-quality fixed income, but we are looking to selectively increase portfolio risk where we see changing dynamics underappreciated by market participants. Horizon appreciates your business and trust through this unprecedented time in markets and the global economy. We look forward to continuing to help our clients meet their financial goals in the years ahead.
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. Any information about performance, allocations, and contributors and detractors is illustrative of Horizon’s model strategies and is therefore hypothetical and not representative of any specific account. 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. Information obtained from third party sources is believed reliable but has not been vetted by the firm or its personnel.
Any risk management processes described herein include an effort to monitor and manage risk, but should not be confused with and do not imply low risk or the ability to control risk.
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.
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NOT GUARANTEED | CLIENTS MAY LOSE MONEY | PAST PERFORMANCE NOT INDICATIVE OF FUTURE RESULTS