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June 3, 2020

Dear <<First Name>>,

Please find below our performance and market commentary for this month.


Orthogonal Global Fund ended May with a preliminary net return of -0.61% on the month for Series B investors invested since inception. This brings the Fund's 3-month and 12-month trailing net return to -3.99% and +8.57%, respectively, with correlations to broader market indices of just 0.06 to 0.28 and annualized volatility of only 6%—less than a third of the volatility exhibited by the U.S. equity market over the same period.

The chart below shows gross performance attribution for May. Currency strategies remained the bright spot, posting small gains offset by small losses across the other asset classes. Overall, 20-day trailing volatility on a gross basis remains well below target at 5.4% annualized and month-over-month returns have been muted, reflecting the system's continued preference for lower risk-taking in an uncertain market. We expect this to revert to normal as and if the market continues to stabilize.


Benchmark performance and other statistics are provided in the tables below. Fund performance figures are inclusive of fees. Under standard terms, Series B interests are subject to a 0% management fee and 20% performance fee with a carry-forward loss adjustment.

Summary statistics are provided in the table below. 


The shelter-in-place policies during April and May were effective in slowing the transmission of COVID-19 and "flattening the curve" to ease the burden on hospital capacity. The reopening of Europe in May did not lead to a substantial uptick in daily incidence, remaining stable at 3,470 per day in May down from 17,877 per day in April. In the U.S., daily incidence was 23,358 per day in May.

On the policy front, China, Europe, U.S., and Japan all committed to further fiscal easing, announcing or proposing substantial packages equal to 9.5%, 5.9%, 1.4%, and 6.2% of their respective domestic GDPs.

Markets responded well to continued fiscal policy support and the easing of shelter-in-place policies. The S&P 500 and S&P Goldman Sachs Commodity Index ended May up 4.76% and 16.37% on the month, respectively. Year-to-date, the S&P 500 is down just under 5%.

Despite the S&P 500's sharp bounce from its lows, the labor market remains a different story. The May jobs report, scheduled to be released on June 5, is expected to show U.S. unemployment at an astonishing 19.5%. With the nation engulfed by the tragic murder of George Floyd in Minnesota, and unemployment elevated, it appears that tumultuous times lie ahead.

Mixed signals

The first half of 2020 saw a growing disconnect between financial market performance and economic indicators. Stock market returns as measured by the S&P 500 have been resilient on a year-to-date basis, despite record unemployment and other headwinds dominating the news. This month we analyze two potential causes of the disconnect and show that while the S&P 500 may be a good index to invest in, it is a poor representation of the broader economy. Specifically, we show that the COVID-19 pandemic has led to (i) heightened disparity of S&P 500 constituent returns and (ii) because of this disparity, S&P 500 index returns have been driven predominantly by a small subset of firms, namely Facebook, Amazon, Netflix, Google, and Microsoft (the so-called FANGM). Because these stocks have relatively low labor input, their outsize performance is not representative of the broader labor market and the overall economy.

Swimming naked

Warren Buffett observed in relation to the stock market that "a rising tide lifts all boats . . . only when the tide goes out do you discover who is swimming naked." Shelter-in-place orders implemented in the effort to fight COVID-19 challenged the expansionary bull market of the past three years, putting many firms to the test and sharply dividing winners from losers. In the chart below, we plot the standard deviation of the daily returns of the S&P 500 constituents as a measure of the disparity of their returns.

Source. Orthogonal, Reuters.

Return disparity has recently jumped to levels not seen since the Great Financial Crisis. In times where disparity is high, S&P 500 market performance may be a poor barometer of the overall economy because it can mask the severity of the downturn for a large segment of the economy. To make this more concrete, we break down the S&P 500's constituents into economic sectors and in the table below we tabulate the simple average of each sector's year-to-date returns as of May 29, 2020.
Source. Orthogonal, Reuters, IBES.

The data shows that while the S&P 500 is down only -5% in 2020, this relatively resilient performance is misleading. Of the ten sectors plus FANGM, only three show positive returns with an average gain of around +8%. This robust performance sharply contrasts with the -15.9% average return across the eight sectors showing year-to-date losses. In times of high return disparity, the market cap-weighted return to the S&P 500 index of -5% obfuscates what is actually happening to large sectors of the economy.

Winners keep winning

Because the S&P 500 is weighted by market capitalization and re-balanced quarterly, over time it tilts ever more heavily towards the winners and away from the losers. When growth is even and broad-based, its relative weights remain stable. In times of high return disparity, divergence between its relative weights accelerates.

The spectacular growth of FANGM in the past ten years has resulted in a group of just five companies, representing only 4% of the total labor force employed by the S&P 500, making up close to 16% of the total S&P 500 market cap-weighted index as of year-end 2019. Despite close to 55% of the S&P 500 labor force being employed in sectors experiencing extreme market downturns, the outsized impact and outperformance of FANGM on the index has propped up year-to-date returns. The severe return disparity between FANGM and the rest of the S&P 500 underscores the divergence between index performance and the actual experience of the labor market.

Leaving the echo chamber

To arrive at a more representative market-based indicator of economic health, we introduce an employment-weighted index. This version of the S&P 500 index weights each constituent's returns by its share of the S&P 500's total labor force as of 12/31/2019 with no rebalancing. Our employment-weighted index is equivalent to calculating the average market return to each S&P 500 employee and can be seen as a rough proxy of the return to each unit of labor. Because FANGM only represents 4% of the total S&P 500 labor force, its weight is significantly reduced in this measure.

In addition, for ease of comparison, we create a version of the S&P 500 that uses the market cap weights of its constituents as of 5/29/2020 and holds those weights constant historically. (As mentioned above, the actual S&P 500 re-balances its weights quarterly.) Below we plot the performance of our employment-weighted index (in red) and our fixed market cap index (in black) for 2020.

Source. Orthogonal, Reuters.

The fixed market cap index is roughly unchanged year to date. On the other hand, the employment-weighted index is down roughly -11%. We believe the employment-weighted index more properly reflects the deterioration in current economic conditions for the labor market by correcting for the outsized impact of FANGM on the S&P 500's market performance.

*Note that the fixed market cap index outperforms the actual returns of the S&P 500. This difference arises from holding the 5/29/2020 weights constant backwards through time versus the S&P 500's methodology of using market cap weights with quarterly rebalancing.

Don't fight the Fed—but do correct for it

While the employment weighted index does a much better job as a market-based indicator of economic health, it does not correct for the effect of recent Federal Reserve actions. The Fed has injected liquidity into the markets at an astonishing speed and scale, increasing the money supply (as measured by M2) from just over $15 trillion to over $18 trillion in less than six months. This flood of money helped stabilize and boost asset prices.

To correct for the impact of the Fed, we look to our commentary from last month. There we provided theoretical and empirical evidence that the price of gold is responsive to—and indeed has close to a 1:1 relationship with—M2. As such, we use the price of gold to correct for the impact of increased money supply. In the chart below, we adjust our employment-weighted index and fixed market cap index by the price of gold.


Source. Orthogonal, Reuters.

In "real" terms, the fixed market cap index is down -12.7% year to date and the employment-weighted index down -21.8%. We believe the latter indicator, which adjusts for both employment and monetary stimulus, paints a more accurate picture of the broader economic environment than the market cap-weighted S&P 500 followed by market watchers. It also explains the discrepancy between the most severe recession in history and the apparently resilient performance of the financial markets.

Putting it all together

We leave you with a plot of our "real" employment-weighted index (reflective of the experience of the average household) against the "nominal" fixed market cap return index (the experience of the average investor).
Source. Orthogonal, Reuters.
The disparity is striking. The growing wedge between the experience of the average household and the experience of the average investor underscores how the difficulties faced by households are not reflected in stock market performance. These economic challenges are real and exist alongside civil rights protests and the ongoing pandemic. The precariousness of this environment cannot be overstated.
Under these circumstances, we believe wealth distribution in the form of minimum wage increases, tax hikes, or other measures will come to the forefront as a policy topic, particularly as the election draws near. In the past few days, presumptive Democratic nominee Joseph Biden's odds of winning the presidency has risen by four percentage points (per Should Democrats take control of the White House and Congress, the pressure on them to take action to address the nation's challenges will be sky high.
This concludes our commentary for this month. As always, we look forward to your questions and thoughts.

Dion Chu

+1 (847) 508-8270

Michael F. Peng
+1 (415) 265-4183

This communication is strictly confidential and is intended exclusively for the use of the person to whom it was delivered by Orthogonal Asset Management, LLC ("Orthogonal"). It may not be reproduced or re-transmitted in whole or in part without authorization. The contents of this communication and any attachments are solely for information purposes and are provided for your internal use only. Nothing contained herein constitutes 
an offer, solicitation, or recommendation to sell, or an offer to buy any securities, investment products, or investment advisory services.

This document may contain forward-looking statements and projections that are based on Orthogonal's current beliefs and assumptions and on information currently available that Orthogonal believes to be reasonable. However, such statements necessarily involve risks, uncertainties, and assumptions, and recipients may not put undue reliance on any of these statements.

Although the information provided herein has been obtained from sources which Orthogonal believes to be reliable, Orthogonal does not guarantee its accuracy, and such information may be incomplete or condensed. The information is subject to change without notice. Since Orthogonal furnishes all information as part of a general information service and without regard to a recipient's particular circumstances, Orthogonal shall not be liable for any damages arising out of any inaccuracy in the information.

The information in this presentation is not intended to provide, and should not be relied upon for, accounting, legal, or tax advice, or investment recommendations. Each recipient should consult their own tax, legal, accounting, financial, or other advisors.
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