Investment Highlights – Second Quarter 2022

Market commentary

The Fed has many tools at its disposal to control the economy’s primary variables such as interest rates, inflation, and its currency strength. But what happens when the Fed loses complete control for one of these variables? In the case of inflation, a recession becomes the play. This is a controversial topic as of late to discuss, but the excess buying power and cheap money floating in the economy can only be controlled through a Fed-Induced recession. This insinuates more aggressive interest rate hikes and an overall tightening of the financial conditions throughout the U.S. economy. Analysts across asset classes are currently adjusting their expectations for profit and revenue generation within their respective companies and sectors. A recession in any form brings stress to all asset classes. During these uncertain times, timing becomes even more irrelevant when deploying capital into risk assets and an appropriate action plan is required to navigate the current environment. However, few things remain certain, with one of these being that interest rates are rising. We could expect this rising rate environment to continue for another 6 to 12 months. This is all depending on how quickly inflation can be controlled and what level on inflation the Fed wants to “normalize”.

Another primary concern during strenuous economic times is investment liquidity. Dealing with uncertainty means that having easy access to your capital is of the highest priority. Throughout the Saint Joseph Investment infrastructure, we are prioritizing moving client assets to highly liquid marketable securities where transparent pricing is always available. During the market’s most volatile days, lack of liquidity can turn into an investor’s biggest disadvantage. This opens the possibility for intermediaries to hide elevated transaction costs and provide misleading market context at the time of execution.

Saint Joseph prefer to mitigate this risk and remain allocated in the most efficient parts of the capital markets.

It is no mystery to either retail or institutional investors that we are amid an “equity winter”. With the aggressive repricing of growth stocks and cooling sentiment for the asset class, many investors remain on the sidelines. One clear indication of this slow- down is the drop-in activity in the primary markets. Adjustments in valuations have made it less attractive to take private companies to the public markets and cover the hefty fees to undergo the process.

This edition of the Saint Joseph Investment Highlights intends to bring us back to the basics of investing and portfolio construction. The advisory team’s primary objective for the second half of the year is to control volatility while begin participating in efficient upside capture in the equity markets.

– The Saint Joseph Investment Advisory Team –

Equity: The case for passive investing

One of the most highly debated topics of all time in the world of investment management is whe- ther to actively manage your equity portfolio or passively invest and let the market cycles grow your money over the long term? This argument can be more precisely traced back to Eugene F. Fama’s Nobel Prize-winning paper “Efficient Capital Markets: A Review of Theory and Empirical Work”. Here, Fama makes the compelling case for information efficiency in the markets and as a result, states the fact that over the long run, professional active money managers cannot outperform well-diversified passive investments. We understand that markets can have brief moments of erratic behavior and irrational pricing, but we do not believe it is consistent enough to produce a long-term investment management strategy. We will proceed to highlight this point with a simple study. If we were to have entered the market annually each time over the last 10 years at the highest point each calendar year, we still would have produced a total return equivalent to 67% since the year 2012.

Unfortunately, the same cannot be said about the hedge fund industry where on average fund managers have returned 58.6% to their investors over the same period. This also does not consider the high fees and lock-up periods that investors agree to at the start of their investments with these funds. We think for it to be truly bad luck to “buy the top” 10 years in a row, thus, we want our readers to look at this simulation as a “worst-case scenario” for passive investing. This simulation also assumes that the investor only bought the S&P 500 once a year for the same dollar amount each time. Commissions and standard management fees are also not considered. Returns could vary for other indices and instrument liquidity is never guaranteed.

Regarding fees and expenses paid by investors, passive investing also offers an advantage: investors will save money in the long run with commissions and product expenses embedded within the instrument. As we can see below, the difference in expense ratio between the average equity Mutual Fund and the three primary index ETFs is significant.

Fixed Income: Capturing roll and playing the curve

It might be counter-intuitive thinking that fixed income strategies during a rising rate environment might provide opportunities for investors, but when examining the current shape of the yield curve, positioning your portfolio in short-term maturities could provide enhanced returns. Our current fixed income positioning is being focused around 2-year maturities and durations. We can begin to structure the rationale for this by obser- ving yields in treasury bonds.

Starting at the 2-year maturity, we notice that the shorter maturities begin to drop in yield dramatically. What does this imply for our fixed income positions at 2-years? This implies that we positioned to capture “Roll-down returns”. This term refers to the behavior of yields as they approach maturity.

By just holding on to a 2-year bond, the yield should drop over time. In this curve (and most curves in this editorial are concerned) the coupon rates are fixed, so with yield compres- sion you should see an appreciation in the price of the bond.

This strategy helps cushion fixed income portfolios against interest rate volatility when the current trajectory of rates is upward. If we were to extend the duration of our positions, there would be virtually no pick up in yield for taking additional interest rate risk. The shape of the yield curve changes on a daily basis in the treasury markets, so this positioning could change with time. If we layer the corporate curves (which takes the average yield for the given maturities of all issues) separated by credit rating, we can observe that the investor has a wider range of maturity allocation so that they could capture this “Roll-Down Return.” Given the evidence presented below, this defines our preferred range for purchasing corporate credits between 2 to 4 years of duration.

Appendix: About the ETF's

What are ETF's?

Like Mutual Funds, ETFs are funds created by managers whose particularity is that they are listed on stock exchanges and traded throughout the day. Commonly, these funds agglomerate a vast amount of assets under management, giving their investors the possibility of participating in the market movements of a set of financial assets. In fact, these assets generally make up market indices (eg: S&P 500, Nasdaq, Russell 2000) therefore, since it is not possible to invest in indices directly, investors use this instrument as an alternative to participate in their movements.


ETFs are created by fund managers and large financial institutions such as Vanguard, iShares, Blackrock, ProShares, Barclays, JP Morgan, PIMCO, among others. Each manager has a set of ETFs covering all sectors and asset groups that have one or more similar characteristics.

Expense Ratio

One great advantage that these instruments have in, comparison to Mutual Funds, are the expenses. This type of fund has a single cost called “Expense Ratio” which is usually less than 1%. On the other hand, Mutual Funds have various costs: administration and management, entry and exit costs, performance and management fees and costs in case of withdrawing funds before the established date. This results in the remaining money allocated to the strategy in question being significantly less than what would have been invested in the ETFs given that their lower costs.


There is a variant among ETFs called UCITS (“Undertakings for the Collective Investment of Transferable Securities”). This type of funds are regulated by European Commissions, so they are listed on stock exchanges outside the US. This implies that the investors of this class of funds are not subject to US taxes and, in turn, they can choose a sub-class where dividends are accumulated (reinvested) or distributed, which is why investors often use it as a vehicle for tax efficiency matters.

Strategy Replication

Even though most of the ETFs replicates by 100% the behavior of the main market indices, there are some whose replication strategies are partial. This is the case in which it is very difficult for managers to buy/sell all the positions that make up large indices, so they prefer to make a partial selection of the most relevant assets. Therefore, investors would be less exposed to index movements, and would only be subject to variations in those positions selected by the fund manager.


As well as the vast majority of corporate stocks, ETFs distributes dividends to their investors. Usually, these are generally distributed quarterly, although some funds distribute them on an annual basis. However, the investor has the possibility to choose not to receive these dividends by investing in the UCITS ones mentioned before.

Comparison to Mutual Funds

Mutual Funds are instruments managed by large Fund Managers globally and are very convenient to focus clients’ investments on particular strategies designed exclusively by Portfolio managers. However, as mentioned above, these type of asset has higher management costs than those incurred in ETFs. Besides, when buying or selling this financial instrument, the execution price is determined by the end of the day and investors should wait between 2 to 3 days for the operation to be closed and therefore be reflected in the client’s account, which can be annoying at times when liquidity becomes necessary for investors. However, ETFs can be traded multiple times in the same day and are as liquid as stocks. Another great advantage of ETFs is that they do not have a minimum required investment amount, hence, the minimum amount to invest is determined only by the price at which the ETF is traded, unlike Mutual Funds that do require a minimum investment amount.

How does it work?

Let’s suppose that an investor is interested in allocating $1,000 of his portfolio in an ETF that replicates the behavior of the S&P 500 index in order to secure the performance of a part of his global positions the same as one of the main US market indices (commonly used as a benchmark by financial advisors), that is, he wants to ensure that $1,000 fluctuates just like the index. To simplify matters, we will assume that this client prefers to receive it’s corresponding dividends.


In order to achieve this, he contacts his Financial Advisor who advises him to invest in the ETF SPDR S&P 500 Trust that with the following information:

Once the current price at which the ETF is being traded has been observed, the amounts of the asset to be acquired are determined as follows:

As a final result, the investor would buy 2 shares at a price of $384.45 of the SPDR S&500 ETF Trust. It should be noted that as in Equity, ETFs are purchased in units.