The third quarter of 2022 brought “a sea of red” to markets as stocks and bonds around the world sold off, but the weakness in sterling means UK investors were able to eke out some gains. 
One side effect of the weak pound – which has been much covered in recent days – is that overseas holdings perform better than their underlying numbers would suggest. This effect was especially pronounced last quarter.
As part of our regular quarterly review of markets, we’ve looked at the past three months from a range of viewpoints – such as geography, investment style and fund sector. But so sterling-based investors don’t get a false view of what’s happening out there, we’ve also paid more attention to the impact of currency movements.
Currency
The US dollar has been strengthening against its international peers for some time, as the Federal Reserve continues to hike interest rates in its battle against inflation. Added to this is the greenback’s ‘safe haven’ status, which has aided its strength recently as investors worry about the health of the global economy.
Performance currencies vs US dollar in Q3 2022
Source: FE Analytics. Total return between 1 Jul and 30 Sep 2022
As the chart above makes clear, the US dollar appreciated against pretty much every currency in the third quarter of 2022 (the lines show the other currencies versus the dollar, so a downward slope indicates a stronger dollar). Meanwhile, sterling has declined across the board, shown below by a strengthening of other currencies.
Performance currencies vs sterling in Q3 2022
Source: FE Analytics. Total return between 1 Jul and 30 Sep 2022
Of course, the weak pound has dominated in the headlines in recent days after the ‘mini-Budget’ caused investors to worry about the sustainability of UK public finances. The chart above shows how sterling had been weakening against other currencies for some time, before crashing in the days after the ‘mini-Budget’ then recovering somewhat when the Bank of England intervened in the gilt market to bolster stability.
Asset class
The weakness of sterling means that the returns on assets denominated in foreign currencies looks much better for UK investors than in their local currencies. Therefore, for the remaining charts in this article we have shown both the sterling performance (in teal) and local currency performance (in grey).
Starting with a broad view at how the various asset classes held up over the past three months, FE fundinfo data show equities and bonds made positive returns for sterling investors. Investment grade bonds made a total return of 2.8% over the period, double that seen by global equities and government bonds.
However, the picture looks different when the movements in sterling are taken out of the picture. All of the assets we looked at made a loss in local currencies, so much so that Jason Hollands, managing director of corporate affairs at Evelyn Partners, described the third quarter as “a sea of red”.
Performance by asset class in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
In contrast to the earlier part of the year, commodities dropped during the third quarter as investors worried about issues such as US interest rate hikes, Europe’s energy crisis and China’s slowdown – all of which increase the risk of a global recession.
Geography
Again, global equity markets looked a lot better for UK investors than was really the case. Most stock indices lost money over the three months (although Brazil and India were particularly strong), but currency movements meant UK investors enjoyed positive returns in areas such as the US and Japan.
Performance by geography in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
Hollands said: “Currency gains from owning overseas investments – especially in the US – have helped shield UK investors from very steep underlying losses. That’s relatively good news but make no mistake, it is ugly out there across the globe. The third quarter was particularly brutal for emerging markets, Asia and European equities."
Investment style, industry and market cap
When it comes to investment style, momentum and growth were the best performers of the quarter, while value and quality stocks suffered. However, the rotation away from growth stocks and into value remains in play with the value style outperforming growth by a wide margin over the course of 2022 so far despite the third quarter setback.
Performance by investment style in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
Global energy stocks were the highlight of the quarter, making a 7.1% return in sterling and 1.3% in local currencies as energy commodities continue to trade at elevated prices amid supply shortages. It was the only global industry where positive returns were posted in local currency terms.
Performance by global industry in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
And when it comes to market caps, smaller companies held up better than larger ones.
Performance by market cap in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
Fund sectors
Putting all of the above together, we can see how funds in the Investment Association universe fared over the third quarter. Here, we’re only showing the sterling returns.
Performance of equity funds in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
In keeping with the strong returns from India and Brazil over the past three months, it shouldn’t be too much of a surprise to see the IA India/Indian Subcontinent and IA Latin America sectors topping the leaderboard. They are the only two peer groups to make double-digit total returns between July and September.
Chinese equity funds were the quarter’s worst performers as the world’s second biggest economy continues to slow, but UK equity sectors also had a bad run.
Performance of bond funds in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
The strength of the dollar means that funds focused on dollar-denominated bonds were the best fixed income funds in the third quarter while sterling bonds racked up some heavy losses, particularly after the ‘mini Budget’.
Performance of mixed asset funds in Q3 2022
Source: Finxl. Total return between 1 Jul and 30 Sep 2022
All of the Investment Association’s mixed asset sectors made a loss over the past three months, with absolute return funds holding up the best. The worst returns came from those holding higher allocations to bonds, reflecting the weakness in gilts.