Note: As of Nov'21, Endowus Cash Smart Core is now referred to as Endowus Cash Smart Secure. There are no changes in the underlying investment offerings.
- Performance Update: All three Cash Smart solutions reported a positive December monthly return of 0.10% for Ultra, 0.03% for Enhanced, and 0.05% for Secure (Core is now renamed Secure). Cash Smart Secure has not posted a single negative weekly or monthly return since launch; however Ultra posted 3 months and Enhanced 2 months of negative returns before turning positive last month.
- Key Concerns Addressed: The negative returns of Cash Smart Enhanced (Sep-Oct) and Ultra (Sep-Nov) have been cause for concern. The unprecedented combination of rising market interest rates, Asian (China) credit selldown, and a sizeable correction for the fixed income markets overall has led to a longer, albeit shallower, period of negative returns longer than even during the March 2020 Covid crisis. We address some of these issues and key client questions in detail in this article.
- Yield Update: Endowus Cash Smart solutions calculate projected yields based on yield numbers published by the fund management companies as a guide for investors. However, these solutions are inherently investments and therefore are exposed to volatility and periods of negative returns in varying degrees as the portion of fixed income increases in Enhanced and Ultra with corresponding exposure to interest rate and credit risk. With falling bond prices (they get cheaper) and rising market yield (having to pay higher interest to borrowers), the forward yields are continuing to rise.
- Macro Update: The US Fed has signalled an accelerated pace of tightening in all three areas of: i) tapering of bond purchase programs, ii) raising interest rates sooner and at a faster pace, and iii) a reduction in the Fed’s balance sheet, driving yields higher and causing a major disruption to the fixed income markets globally. Meanwhile, Chinese market conditions and structural concerns persist despite the recent improvements in policy and rhetoric.
The three Cash Smart solutions all generated positive returns for December over a one-month period. However, this follows two months of negative returns for Enhanced from September to October, and three months of negative returns for Ultra from September to November. Enhanced has now generated a second month of positive return while Ultra has only posted one month of positive returns.
Rebound in returns
The table below shows the monthly and overall performance (both actual and annualised) of the three portfolios since July 2021, in the past 6 months.
During this time, Cash Smart Secure continued to generate positive returns throughout, of between 0.05% and 0.07% each month, without much volatility and negative months as it was designed to do. Cash Smart Enhanced has also continued its gradual recovery after a period of volatility in October, climbing back to its August 2021 level before the start of market turbulence in September. Cash Smart Ultra, after a rough period of negative returns since September, performed more stably and ended December with a positive monthly return that was greater than Secure and Enhanced for the first time in four months. However, unlike Secure and Enhanced, it is still some way off from recouping losses generated in preceding months that were driven by a confluence of negative drags from the Asian credit sector, especially China, as well as the negative sentiment driven by the US Fed’s increasingly hawkish stance.
Key client concerns are addressed
The role of Risk, Volatility and Returns in our Cash Smart design
The reason Endowus has three Cash Smart solutions is because we intentionally designed it to have different levels of risk, which would mean different levels of returns and the different levels of volatility that we must stomach in order to generate those returns. While the company provides guidance in the length of investments of less than 1 month for Secure, 1-3 months for Enhanced, and 3-6 months for Ultra, investors also need to be mindful of whether the money is for future investment or for other urgent needs.
The most important thing when it comes to investing is always the suitability of the level of risk one is taking, and it is a personal and subjective metric that cannot be measured scientifically. The higher targeted returns of Cash Smart Ultra, for example, would be generated through taking on more risk (as in the chances of you losing money), and the returns generated would also be accompanied with greater levels of volatility.
For those who can only tolerate lower risk and lower volatility, the lower risk product such as Cash Smart Secure, will invariably generate lower returns over time. The correlation between risk and returns is relevant to all types of investments, including short-term cash management products such as the Cash Smart solutions that utilise institutional bank deposits, money market instruments and short duration bonds (fixed income products which are closer in maturity than typical bonds).
It is important to understand that the risk-return correlation is pervasive when it comes to the financial investing space. It applies to even things like bank deposits. Current accounts with no risk, deposit guarantees and completely accessible with daily liquidity offer just 0.1% interest in the market. However, if you lock-in the money as a fixed deposit for a longer period of time, the banks would then be willing to pay a higher interest rate on that money. In doing so, you accept the illiquidity risk, which is also a form of risk-return tradeoff that occurs even with safe saving methods like bank deposits. Therefore one cannot expect higher returns without taking additional risk, and if you want less risk then you will have to settle for lower returns. This is something that even the most sophisticated or professional investors cannot get away from. Across the Endowus platform offerings, this correlation between risk and return would exist as the above chart shows as an illustration.
Endowus Portfolios have moved according to their target risk
Correlations are consistent both during times of positive and negative fixed income returns. We have looked at the recent volatility and examined how the five broad fixed income products have performed in different periods to see if that relationship exists in the Endowus products. These Endowus products consist of the three Cash Smart products, the newly introduced Low Volatility Fixed Income (that replaces the old UDP model portfolio) and the 100% Flagship Fixed Income portfolios.
We stripped out four distinct periods of up and down markets in the fixed income market in the past year. The first was a falling period of a month or so in early 2021. Then the market rebounded and we saw a sustained rally from April to September. We also saw a correction from September to November before the one-month recovery in December. Throughout these four periods, the above chart clearly shows that the correlation between risk and return have played out just as one would expect. With the 100% Flagship showing the highest returns in any up market and the biggest falls during downturns and the safest Cash Smart Secure generating a stable but low return throughout. The remaining portfolios are a sliding scale of risk and returns.
If you were a Cash Smart Ultra investor between April to September you would be very happy as the Cash Smart Ultra generated returns of 1.25% in a less than six months period. If you had started your investment only in September, then unfortunately you would have experienced the period of negative returns without the accompanying positive returns in the earlier months. And if you had started investing in November at the lows then Ultra would be up 0.46% in just one month. However, as with all investments, we cannot time these things and we know that just as there are investors who used Ultra to great benefit and good returns in the past, there are many others who are suffering from losses just like the low volatility fixed income and the 100% fixed income Flagship portfolios in recent months. Cash Smart Secure customers would have felt most assured and content with their stable and secure returns month in and month out.
Endowus Cash Smart products focus on money market instruments or the short-end of the yield curve, which have ultra-short or short durations. This characteristic makes them more defensive than conventional fixed income products with longer durations, especially in an environment of rising interest rates and falling bond prices. However, they are still fixed income instruments and exposed to market volatility. The fall in September to November, while meaningful and sharp, was still much less in terms of magnitude than what was experienced in March 2020. During the shock of the Covid-19 crisis in March 2020, the global fixed income markets had a massive sell-off. This time, the correction is shallower but the length seems to be longer.
Addressing Key Questions on Cash Smart : Question 1
Q: I have been invested in Cash Smart Ultra since September, and my returns are still negative. You indicated a 3 months investment horizon for Ultra so when will it turn positive?
A: We have received this question from more clients as the returns in their Cash Smart Ultra portfolio have remained negative for longer than they had anticipated. Some clients have focused on the 3-month horizon as a benchmark to see whether the portfolio will recover. However, our suggestion of more than 3 months or 3~6 months in previous publications for Cash Smart Ultra was shared to highlight the risk that the portfolio can generate negative returns based on previous historical precedents.
A prime example was during March 2020, when the covid-induced shock hit the fixed income market and all returns turned negative. We calculated how much the total drop was for all three Cash Smart portfolios during this period and displayed this data to give an indication of the magnitude of the loss that is possible in a worst case type of scenario. The length was given as a guidance to suggest that it could take several months, and longer than people may commonly expect for the portfolio to return to the previous high and the March 2020 data served as a guidance.
In March 2020, we saw a -2.6% move in one month. It then took about 2.4 months for Ultra to recover to its previous peak, thus giving a total length of 3.4 months for Ultra to be back at its pre-Covid drawdown level. However, we know that March 2020 was more of a sharp, short shock to the system. The correction that began in September 2021 is turning out to be, so far, a shallower fall of around -1.3%, but the length of the downward trend was almost twice as long, and the recovery is looking like it will take much longer too.
The recent fall in markets has been driven by a convergence of several macro factors. The 2020 March drawdown was a result of the covid-19 induced liquidity shock in the fixed income market. The recent fall was caused by central banks around the world adopting tighter monetary policies coupled with a very specific country and sector shock in the form of the regulatory crackdown in the Chinese property sector. This led to a pronounced and concentrated effect in the China and Asian credit market, in particular the high yield market. In March 2020, the -13.53% fall in Asia high yield index was largely in line with the -11.3% fall for the broadly diversified Flagship 100% fixed income portfolio. This is in stark contrast to the -16.74% fall in the Asian high yield index compared to the -2.17% in the same period for the Flagship 100% fixed income portfolio.
As investors ourselves we can fully relate with clients in this period of uncertainty, volatility and negative returns, and hope to be able to address some of these concerns. At the same time, the nature of investing is such that it will be difficult to anticipate how different segments of the fixed income space will perform, especially when things such as the direction of the US Fed and Chinese government policy-making are very fluid.
Looking forward, we must closely watch where the Chinese government’s policy is headed and their actions with regards to interest rates, liquidity and direct capital injections. In particular, the outlook for the real estate sector is an important barometer (including mortgage loans restrictions and rates). Policy does seem to be turning and implementation has been incrementally positive. However, the overall market sentiment remains fragile and uncertain with a heightened level of volatility seen across credit and high yield markets. Tougher housing policy is what started this downturn and so if we see policy translate to better liquidity to developers and property price falls are limited, then there is a chance that market sentiment could recover barring any systemic threat to stability.
Diversification and single fund risk amidst Asia High Yield drop
One of the notable things about the Cash Smart Ultra portfolio is the greater number of funds included compared to the other Cash Smart solutions. The wide range of funds that make up the Ultra product were chosen for their varying degree of exposure to duration (interest rate) risk, credit risk(the trade-off between yield and chance of default), and also diversification in terms of geographical exposure.
So far this year, the biggest detractor to the performance of Cash Smart Ultra has been the Nikko Shenton Income Fund relative to the other underlying funds. While the diversification towards multiple underlying funds helped, the 12.5% allocation to the Nikko Shenton Income Fund still detracted meaningfully to performance. Generally, any fund with exposure to China, the property sector, and Asian credit/high yield would have seen a meaningful decline and this has been the major factor in the divergence of returns. In fact, apart from this fund, the rest of the portfolio has been relatively resilient.
We have created a chart to show the impact of high yield and Asian credit on recent performance. This chart shows how the overall Cash Smart Ultra portfolio moved versus the Nikko Shenton Income Fund and how the Bloomberg Global Aggregate Index performed versus the iBoxx Asia ex Japan High Yield Total Return Index. You can clearly see that there is a correlation between the Asia High Yield index and the Nikko Shenton Index due to its high exposure to Asia credit with some high yield exposure and especially as an Asian bond fund, its exposure to China credit. However, the move is much more muted for the Nikko Shenton Income Fund.
In our recent communication with the portfolio manager of the Nikko Shenton Income Fund and Nikko Asset Management's fixed income team, it was indicated that the team had taken concrete steps to address the recent underperformance, such as a meaningful derisking through a reduction in China exposure, raising of cash and a stronger focus on higher quality issuers with average credit rating from A- from to BBB+. Cash remains relatively high at 16.5% although some are being deployed into defensive and new regional positions. China remains at a 28% weight at the end of November 2021. We expect continued volatility in the China property sector for the first half of 2022 until there is more clarity in Chinese government policy direction.
Addressing Key Questions on Cash Smart : Question 2
Q: Why are we comparing Cash Smart solutions to Fixed Income? Isn’t this more like deposits or money market funds?
A: Endowus Cash Smart was not designed to be a deposit or a capital guaranteed product. It is an investment product made up of institutional bank deposits, money market funds and short duration fixed income funds, all of which carry with it inherent risk.
When we talk about fixed income, it is a very broad term that encompasses different forms of borrowing, usually with an interest rate component. Therefore, apart from the various bonds that we are familiar with or securitised products, even bank loans and bank deposits can be considered fixed income too.
Cash Smart Secure was built with two funds. one invests primarily in institutional bank deposits, making it the lowest risk of all cash smart funds. The other is a money market enhanced yield fund with some allocation to short duration bonds to enhance the yield. The price of the latter is based on the amortised cost basis which assumes that most holdings are held to maturity thereby limiting daily fluctuation in pricing.
Cash Smart Enhanced was also built with two funds - one that overlaps with Secure is the money market enhanced yield fund but with an ultra short duration bond fund to generate slightly higher yield by taking marginally higher interest rate or credit risk.
Cash Smart Ultra was built with the same enhanced yield fund as an anchor but a series of different short duration bond funds with differing duration, maturity and exposure to credit across diverse geographies, with a low correlation that was designed to dampen the volatility of the overall portfolio.
All the underlying funds are fixed income - whether it is the institutional bank deposits or money market funds or short duration bond funds. What we are doing is managing the duration or maturity schedule of the funds to ensure that the portfolio has a suitable level of risk including volatility versus the expected returns.
Macro & Market Update
Inflation remains the single most talked about issue in markets, especially within the fixed income space. There is growing pressure on central banks worldwide to act as inflation rates remain persistent and stubbornly high, driven by demand recovery, supply side shocks leading to cost-push inflation. The Fed is gearing up to combat this by introducing a faster than expected pace of policy rate normalisation – moving away from its “gradualist” approach by accelerating both the tapering of bond purchases and interest rate hikes, which are now expected to begin in March, based on the Fed Committee's December minutes, along with a faster pace of rate hikes this year. While the market is anticipating more details on the Fed’s economic outlook during the January Meeting, there have already been sharp moves in Treasuries that reflect this increasingly hawkish sentiment from the Fed, with the 10-year Treasury yield climbing above 1.8%. Spillover effects were also seen in the global equity markets, with the impact felt most acutely by richly-priced and outperformers with a rotation from growth to value.
Meanwhile, the Chinese property sector continues to unnerve Asian fixed income markets, with the high yield sector once again underperforming investment grade in December. Some market participants believe that the tighter regulations on the Chinese property sector have already reached an inflection point in October 2021 and hope to see policy easing within the first quarter of 2022. Regardless, heightened volatility and the resulting risk-off sentiment are still likely to persist in the near term.
Market participants continue to adopt a cautious stance, with spillover effects seen in other Asian credit and high yield markets, as well as the higher quality issuers in the space which continue to be penalised as the whole sector has been sold down. Looking ahead, the stubborn inflationary pressure and the resulting hawkish tone from the Fed cast a shadow over the fixed income markets globally. In light of this, investors are reminded to choose investments that reflect and are more suitable for one’s risk appetite.
Addressing Key Questions on Cash Smart Question 3
Q: Why are my Cash Smart returns negative, but the updated projected yield from Endowus remains consistently high or even rising?
A: Endowus Cash Smart solutions calculates projected yields based on yield numbers published by the fund management companies as a guide for investors. However, these solutions are inherently investments and therefore are exposed to volatility and periods of negative returns in varying degrees as the portion of longer duration and higher yielding fixed income increases in Enhanced and Ultra with corresponding exposure to interest rate and credit risk.
Yields of a fixed income portfolio can go up for two reasons. The first is when the price of the bond falls in which case you get the same coupons based on a lower price which increases the percentage yield number. The second is if the maturing bonds return investors’ money and the market yields have risen and so investors are able to deploy cash at a higher interest rate leading to higher yield.
Generally we can say that yields and returns have an inverse relationship in the short term, which means that yields will typically go up when returns go down. Therefore, a rising rate environment generally corresponds immediately to falling bond prices. However, the nature of a bond means that once the bond reaches maturity, its price would recover back to the par level and the previous price losses would be recouped. Investors can then take the returned principal and interest and invest in newly-issued bonds that pay a higher interest. The rule of thumb is that if an investor's investment horizon is longer than the duration of a bond portfolio, rising interest rate in fact improves the return prospect for the investor despite immediate mark-to-market losses due to falling bond prices.
Cash Smart Projected Yield Update
While the Fed’s hawkish stance and the rising interest rate environment are putting pressure on the value of fixed income instruments globally, there still remains a silver lining in the form of yields.
In the medium-to-long term, rising interest rates allow for funds from maturing bonds to be reinvested at a higher rate than before, and will lead to a gradual increase in projected yield. This is the reason for the new revised projected yields creeping up slightly across the different Cash Smart solutions in recent months despite the tough performances we have seen and it is somewhat related also to the lower prices and the fixed coupons of the underlying bonds. The yield range this month remains the same.
Recommended portfolio change to lower fees and improve client outcomes
As part of our effort to ensure that Endowus clients are offered the best-in-class options to build the portfolios and also in keeping to our efforts to provide the lowest cost investment options in the market, we have recently conducted a Recommended Portfolio Change (“RPC”) in November. In the RPC, we switched from using the A share class of LionGlobal Short Duration Bond Fund into the I share class for Cash Smart Ultra. The total expense ratio (“TER”) of the I share class is lower than A share class by 0.062%, and can be invested using both Cash and SRS funding sources.
As a result, Cash Smart Ultra is now cheaper by approximately 0.02% per year. While this may look like a small difference, it is not insignificant as short-term cash management solutions have relatively lower returns. All new clients in Cash Smart Ultra will automatically be invested in the new portfolio. Existing investors will have received an email or notification in-app to accept the recommended changes.
Disclaimer: Investment involves risk. Past performance is not necessarily a guide to future performance or returns. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.
Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.
Investment into collective investment schemes: Please refer to respective funds’ prospectuses for details of the funds, their related fees, charges and risk factors, The listing of units of the fund on a stock exchange does not guarantee a liquid market for the units. Before making an investment decision, you are reminded to refer to the relevant prospectus for specific risk considerations which are available. Please note that the prospectus, profile statement, product highlight sheet, fund factsheet or other offer or product documents may contain references about the expected risk tolerance of their target investors. These are in no way indicative of how we at Endowus have assessed your risk tolerance based on your stated objectives and financial situation. Endowus accepts no responsibility for investment decisions made in response to the expected risk tolerance levels mentioned in the product or offer documents.
For Cash Smart Secure, Cash Smart Enhanced, Cash Smart Ulta: It is not a bank deposit and not capital guaranteed, and is subject to investment risks, including the possible loss of the principal amount invested. Investment products are not insured products under the provisions of the Deposit Insurance and Policy Owners Protection Schemes Act 2011 of Singapore and are not eligible for deposit insurance coverage under the Deposit Insurance Scheme. Interest rates are indicative and subject to change at any time.
Product Risk Rating: Please note that any product risk rating (the “PRR”) provided by us is an internal rating assigned based on our product risk assessment model, and is for your reference only. The PRR is subject to change from time to time. The PRR does not take into account your individual circumstances, objectives or needs and should not be regarded as advice or recommendation to purchase, hold or sell the any fund or make any other investment decisions. Accordingly, you should not solely rely on the PRR in making your investment decision in the relevant Fund.
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