State Street Global Equity (SST0050AU) Report & Performance

Over the course of 2022, the AQE team had plenty of opportunity to analyze sharp drops in the equity market, and shape different views of volatility and equity risk. Broadly, the team was reminded that traditional high risk segments do not always underperform in market drawdowns. This concept was notably demonstrated when Energy stocks outperformed the rest of the market even when the market was down sharply.

Furthermore, we sought to highlight nuances associated with our preference for “low risk” stocks during the year. In 2022 our cornerstone thematic signals — Value, Quality, and Sentiment — pointed toward lower risk names more than was typical in other years. Yet throughout the prior year, we also had a strong preference for Energy stocks (high risk), and generally a negative view on the Real Estate sector. Our team also reflected on the lack of cushion that traditionally lower risk segments like Real Estate, Utilities, and Telecommunications had during last September’s sell-off. The events of September stood out as an unusual drawdown because the relative pay-off to low-volatility stocks was notably lower than is usually the case. Our explanation of why these events played out the way they did is because of the importance of the dimensions that we specified above in predicting stock returns — Value, Quality, and Sentiment measures.

As we look out to 2023, fundamentals, diversification of factor exposures, and retaining high quality or defensive exposures are the themes investors should be focused on in equity portfolios. The equity market drawdown in 2022 creates a valuation cushion as compared to the end of 2021; however, other risks, and the macroeconomic and market conditions that were prevalent last year still abound. Although we may have passed peak inflation, the outcomes of the fine balancing act for central banks globally between inflation, interest rates, and growth risks still need to play out.

With that uncertainty we expect elevated levels of market volatility to persist and Sentiment reversals to be common. We therefore believe it is important to balance exposures within a portfolio — for example marrying Sentiment exposure with Quality and Value factors. Similarly, we favor balancing investments in traditionally low risk sectors with more cyclical exposures rather than betting on one very specific path for the economy. Importantly, this balanced approach enables fundamentals and diversification to guide our stock selection.

When tracked as a standalone signal, sustainability has delivered strong results, over the last three years. In fact, when compared with our core themes (Value, Sentiment, and Quality), sustainability delivered returns almost as high as sentiment and value, but with lower volatility, and delivered a higher return than quality.

The Active Quantitative Equity (AQE) team has been closely examining the September equity drawdown to better understand what was “conventional” versus “unconventional” about it and how these findings inform the AQE team’s process. September’s decline of more than 9% was the eighth worst monthly return for the MSCI World Index in 30 years. Historically, investors concerned about a market drawdown have looked to lower-risk, defensive segments like Real Estate, Utilities, Telecoms, Consumer Staples, and Health Care. And investors concerned about a market drawdown have also typically avoided higher-risk segments like Financials, Materials, Industrials, and Technology.

The AQE team sees a relationship between improving Conference Call Sentiment and cyclical versus defensive characteristics broadly. The global economy has been stuttering this year, and company management and investors are worried about the impact of inflation and slowing growth on company earnings. It is understandable, therefore, that the majority of the industries with “attractive and improving” quarter-over-quarter CCS scores are non-cyclical or defensive in nature, as they are better able to withstand the current environment. The opposite is true within the “attractive but declining” bucket, where the majority of industries are cyclical and the outlook may be starting to wane.

Among industries with unattractive CCS scores, we again find a relationship with cyclicality; the majority of industries where management is showing less confidence reside in the cyclical space, notably Financials and IT Hardware. However, some industries do not show a relationship between CCS and cyclicality.

The Internet and Direct Marketing Retail, Air Freight and Logistics, and Road and Rail sectors are cyclical but have a CCS factor that is positive and still improving. On the flip side, management in Health Care Technology and Household Product companies, although within naturally defensive sectors, seem less confident about the outlook and demonstrate a declining CCS.

By design, the Active Quantitative Equity (AQE) team’s alpha model favors securities with high-quality balance sheets, reasonable growth expectations, improving market sentiment, and attractive valuations. Focusing on these themes can lead to differences over time in the riskiness1 of our most preferred stocks. Because of current market conditions, our most preferred stocks at the moment are, in total, quite a bit less risky than the average stock. In fact, each of the three main themes we focus on — Value, Quality, and Sentiment — are all pointing toward lower-risk names than has been typical for AQE over time (see Figure 1).

By some measures, the Energy sector is high risk; however, we hold a very positive view of that sector overall. How can this be? Let’s take a closer look.
Due to the tremendous increase in both Sentiment and Quality metrics within the Energy sector over the last year, as well as the improving Valuation scores, our model sees the Energy sector — broadly one of the highest-risk segments of the market — as the most attractive of all sectors.

As of the end of May, the Energy sector on average, using our measure of risk, is the second most risky sector, only trailing Consumer Discretionary stocks, the riskiest sector, by a tight margin. While the Energy sector is up over 50% year to date, earnings-per-share (EPS) growth estimates are up over 60% this year, outpacing the index. We think the Energy sector is even more of a bargain than it was at the start of the year. This has led to a decline in the price-to-earnings ratio (P/E) of the sector broadly. As a result, we continue to find opportunities in the sector. A few segments of the Energy sector that we like are highlighted in Figure 2.

Real Estate is another sector that shows how our process, although risk-aware, is not overly constrained by its influence. The Real Estate sector is one of the least risky; however, it ranks as one of the lowest categories from our total alpha perspective. This is largely driven by extremely poor valuation across the board, coupled with varying levels of Quality and relatively average Sentiment metrics. Real Estate has had a challenging year to date — down nearly 15% — while EPS estimates for the sector have been flat. We do not see this trend easing, particularly on
the corporate Real Estate side, as companies move to more remote and hybrid return-to-work models for their workforces.

Although the sector has experienced a slight decline in multiples, we still view the sector as more expensive than other parts of the market. When combined with unappealing Quality and Sentiment scores, our outlook for the sector becomes poor (see Figure 3).

Risk is often associated with a particular sector or segment of the market. In reality, however, risk usually does not appear in isolation. Instead, risk manifests within sectors, industries, regions, or countries (or combinations of these) simultaneously. In assessing risk and its complexities, the AQE team relies on a balanced, disciplined, and diversified bottom-up approach, which allows us to effectively target opportunities as they present themselves — even when views on risk within sectors diverge.

The State Street Global Equity Fund (‘the Fund’) seeks to outperform the MSCI World ex-Australia Index (“the Benchmark”), before management costs, over a full market cycle of approximately 5 – 7 years, with lower volatility than the Benchmark. It also seeks to mitigate currency risk associated with the Benchmark.