Coronavirus market update

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Latest update - 6 April 2020

Governed Range update from Lorna Blyth, Head of Investment Solutions, Royal London Intermediary

The first quarter of 2020 was one of the worst we have ever seen. Economic data shows a shrinking economy with the UK services sector contracting the most as the impact of Coronavirus continues to dominate life. Many stocks are cutting dividend payments and it appears that no industry will ultimately be immune. This lack of good news and visibility around when we may return to something approaching normality is reflected in double digit falls from equities, commodities and high yield. Conversely market uncertainty is driving up demand for UK gilts which have delivered positive returns over the quarter. Property has been largely flat however we do expect some downward movement in the market as a result of the valuation uncertainty clauses which have now been added by independent valuers. This should be seen in the context of the current market and extreme volatility and our view is that property continues to offer valuable diversified exposure for our customers, particularly at this time.

These returns remain within the range of scenarios we model as part of our governance and oversight process for the Governed Range. We continue to follow our enhanced monitoring process throughout this period and have scheduled a special meeting of our Investment Advisory Committee for Wednesday 8th April. This allows us to discuss the impact of recent events on our investment strategies. We will continue to keep a close eye on economic indicators and market sentiment factors which inform our models and review any impact on our longer term assumptions. Rest assured that if these are triggered, we will take action to adjust our strategic asset allocations which set the guidelines for our tactical positions. This will be done through our governance process and will follow recommendations from our Investment Advisory Committee. The portfolios remain well diversified across a range of asset classes and as long term investors we are well placed to take advantage of the buying opportunities when the time is right. “

Please note that this is a fast-moving environment and markets and impacts on portfolios are changing. Opinions contained in this document represent views of our fund managers at time of writing.

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Governed Range investment activity

Stock markets bounced sharply last week, after a violent sell-off earlier in March, with more optimism on counter measures to mitigate coronavirus related damage to the global economy, after the USA has approved a $2 trillion dollar package; however, markets have seen more volatility and weakness this week as uncertainty over both the depth and duration of the health and economic crisis remains high.

We have moved to be broadly neutral in equities but have not gone underweight as US and European public health experts are beginning to talk of some hope regarding the virus impact peaking which may lead to lockdowns being eased; also a broad range of monetary and fiscal stimulus measures have been announced which will significantly help growth once restrictions on activity can be eased. We remain slightly overweight US equities (including the tech sector) given the relatively defensive nature of the market; we are also moderately overweight emerging markets, potentially a safer haven as the virus appears to be under control in China. We are underweight UK equities, a long-term underperformer hampered by a heavy resource sector weighting. We remain overweight high yield bonds, particularly short duration high yield, as we expect the asset class to be resilient over the medium term. We remain broadly neutral on UK commercial property where we have seen diversification benefits relative to equities. We have de-risked our currency positions, remaining short the economically-exposed Australian dollar and more recently moving short sterling while shifting in favour of the more defensive US dollar and Japanese yen.

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Market outlook, Trevor Greetham, Head of Multi Asset Funds, Royal London Asset Management

“We may not yet have seen the lowest point in equity markets as the virus is spreading rapidly in the US and Europe with volatility remaining high. Sustained recovery in markets will probably have to wait until there is more confidence on the virus being under control globally, shuttered parts of the world economy are re-opened and consumer confidence rises from its lows as people are allowed to return to work. We expect our Investment Clock model to reflect this situation by moving quickly into disinflationary Reflation before moving sharply upwards into Recovery when the crisis ends. We intend to make full use of our active tactical asset allocation risk budget to add to equity exposure when we judge the time is right.

Our investment process has weathered difficult markets in the past and we added significant value over the 2007-9 Global Financial Crisis. We believe a disciplined and active approach to both risk control and tactical asset allocation will be crucial in portfolios, as markets respond to the current crisis and policy responses being implemented.”

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Royal London Asset Management Economic Viewpoint

Although there has been some encouraging news from countries where the growth in new cases has been slowing, it is clear from incoming case numbers that we are still some way off being able to contemplate easing social distancing measures in Europe, let alone the US. In the meantime therefore, levels of economic activity remain well below pre-crisis norms. Data has underscored the challenge facing policymakers. Over the week, the latest US weekly initial jobless claims number showed another a record jump of more than 6 million. Benefit claims have risen sharply in the UK too and incoming March survey data reflects a large hit to business activity and confidence in Europe and the US.

Economic activity data in China has improved as social distancing measures have eased and March business surveys show significant improvement. However, business surveys generally ask firms whether activity has increased or decreased, not by much. That is important in the current context where the level of economic activity is likely still significantly below pre-crisis levels. Export-related components of the surveys still signal contraction, consistent with weak global demand now holding back China’s recovery. Meanwhile reminders that things aren’t normal and that social easing can’t be unwound in one easy move while there is re-infection risk, came in the shape of some reversals of social easing (e.g. cinemas shutting again and lockdown being re-imposed in Jia county).

In the US unemployment numbers this week highlight the scale of the challenge policymakers face in trying to limit the long-term economic damage from this crisis. The good news is that policymakers globally continue to step up and introduce measures that improve the likelihood of economic activity being able to pick up robustly once social distancing measures ease. Again, we’ve seen measures designed to keep the financial system working (e.g. Fed’s announcement this week of a repo facility for overseas central banks), limit damage to household finances (e.g. the direct wage subsidy scheme announced by Australia at the start of the week) and keep viable businesses afloat. Other highlights included a 50bps rate cut in Canada late last Friday and a policy easing message from Chinese authorities.

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Market view from Piers Hillier, Chief Investment Officer, Royal London Asset Management

"In the past week, the number of confirmed COVID-19 cases around the world has more than doubled. The global total now stands at over one million, and the US has taken on the mantle from Europe as the new epicentre of the crisis with around 250k confirmed cases; more than double any other country. We had noted last week that the 3.3m US jobless claims two weeks ago far exceeded previous records and economists’ expectations. It emerged yesterday that the number of claims for first-time unemployment benefits surged to 6.6m in the past week, shocking economists once again.

The survey data that has been released today reiterates the sharp contraction in economic activity, with the composite PMI figures hitting all-time lows across the UK and the eurozone. Sweden has adopted a less draconian approach to managing the pandemic and whilst economic activity there also slowed in March it was relatively muted by comparison to the dramatic falls in Italy and Spain that have been in lockdown. In light of these economic challenges, the credit rating agencies have been aggressively downgrading their assessments of companies. According to a report from Bank of America, March featured the most downgrades since records began in 2002. Among them, Fitch downgraded the UK to AA- from AA on account of the country’s “loosening fiscal stance” and weakening public finances.

As many companies appealed for help in the form of governmental bail-outs, regulators made it very clear that such companies should not be distributing dividends to their shareholders. Under pressure from the UK’s Prudential Regulation Authority, the UK’s banks announced that they would cancel dividend payments for 2019, as well as withholding 2020 dividends and share buybacks, this despite all of them passing the Bank of England’s stress tests last year. The total cut to UK dividend pay-outs could well be around 50%, which compares to only 14% during the global financial crisis. The same theme can be seen in Europe whilst many companies in the US have suspended share buy-back programs. Whilst prudence is rightly front of mind as we tackle this major economic shock, we must remember that dividends play an important part of meeting the income needs of small investors and in particular pensioners.

Despite the gloomy backdrop, sentiment and liquidity actually improved in a number of markets over the week. Of particular note, the high yield credit market, which had been beaten up for much of the crisis owing to its riskier characteristics, saw record inflows amid a seven-day rally. Supported by accommodative central bank policies and higher oil prices, investors flooded back to the sector in pursuit of the income it could offer. Given the pressure on dividends, we feel that the search for income – a significant issue for many clients given the demographics in developed markets – is about to become even more challenging.

Brent crude oil enjoyed its biggest ever one-day rise on Thursday, with the commodity settling 21% higher having been up as much as 46.7% at one point. The spike came after President Trump, who is overseeing negotiations between Russia and Saudi Arabia in an effort to stop their oil price war, said that he expected the nations to cut production by approximately 10 million barrels a day. Trump’s announcement was, however, given a cool reception by the two countries and they refused to publicly commit to any such cuts, but agreed to convene a meeting of OPEC next Monday.

The past week has seen a few tentative signs of normality. While conditions are still stressed, the new issue market has been operating in both investment grade and high yield bond markets. This doesn’t mean that we’re on a fast-track back to where we were before the crisis, but it is an important and positive marker in the proper functioning of markets. As you would expect, our credit teams analysed these as they would other deals – notably passing on one high yield deal that was heavily oversubscribed and paying a high coupon as the fundamentals didn’t add up for us. This is the sort of work that you have to do as active managers, and while some aspects of this are going to change, the basic process does not."

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Equities

In tough economic times, when assessing existing holdings and new investments, our primary focus is the balance sheet rather than the profit and loss account. As a consequence, we have spent a lot of time recently reviewing balance sheets of portfolio companies, as well as the relevant covenants attached to banking facilities and the financial liquidity available to companies overall. We have tried to stress test the earnings and balance sheets of our holdings in scenarios where future profits (and cashflows) could be significantly lower depending on the time their end markets are in lock-down. Cineworld, Weir and Senior were sold after this exercise.

There are others which appear in need of more capital, but we believe could be the beneficiary of a significant valuation uplift if they were to raise money, thereby removing solvency risk through this period of uncertainty. Investors are sitting ready at the sidelines with cash, with relatively few fund outflows and a willingness to support good companies who have been caught out by the sudden and catastrophic impact of this virus. Recent equity issuances by City Pubs, SSP and Ten Entertainment were all over-subscribed, and the shares subsequently rallied to trade at significant premiums to their placing price – evidence of investor support.

It is clear that earnings expectations throughout the market remain too high and need to adjust to the full implications and ramifications of the virus and its medium-term effects on industry and consumers. Even companies that appear well capitalised may struggle in an environment where revenues could disappear for a period of weeks or months. With this in mind, many companies have taken the decision to cut their dividend, suspend all but essential capital expenditure and cut operating costs to a bare minimum. This will have a very real effect on economic growth in 2020, and associated mass redundancies are likely to have a damaging effect on consumer confidence that outlasts the virus itself.

Despite this, there is a real difference between this economic period we are entering and previous recessions. We have consistently heard from companies across the market that banks are much more supportive than typical and are prepared to waive financial covenants for 6-12 months and extend banking facilities to what they see as otherwise solid and successful companies. These financial institutions are willing and able to do this because they approach this downturn with relative financial strength and repaired balance sheets (following the 2008 credit crisis). The government is also encouraging this behaviour and has been fast to provide support in the form of ample liquidity to bank funding markets.

Within active global equities we are increasingly positive on long-term valuations for equities given the recent market falls, the increasingly accommodative monetary policy and the lack of return in many alternative asset classes. It has been a slightly disorderly market driven by what appears to be quantitative and macro funds rather than long-term stock pickers. At the stock level we see individual investment opportunities across the corporate Life Cycle and across sectors and are utilising our process to identify these and increase holdings where the price is right.

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Property

The RLP Propery Fund was suspended on Monday 30 March 2020.

Sentiment in the real estate sector is contingent on many factors, but the underlying health of the economy plays a fundamental role.

A significant slowdown is now underway. Prior to this crisis, values of retail properties were already in decline, with the other main market sectors stable or rising, off the back of the December General Election result. However, across most sectors we now expect to see an increase in property yields and for asset valuations to fall, as a combination of investor uncertainty and near term occupier stress take hold. RLAM are no longer proceeding with a number of investment transactions and expect others to take stock and pause, whilst the ramifications of this global crisis become clearer.

Investment volumes will therefore be suppressed. There are signs that some private equity funds are still active and seeking opportunities, particularly in the industrial sector. Recent deals saw transactions completed last week achieve, and even exceed, asking prices. This demonstrates the view that despite current uncertainty, key industrial locations could benefit from the growth in online and last mile logistics. However, we expect these types of deal to be in fairly short supply.

As social distancing intensifies following the government’s soft lockdown approach, the effects are already beginning to appear in economic indicators. One recent example, particularly pertinent to the property sector, saw this week’s statistics indicating that certain London retail destinations have seen a 90% decline in footfall year-on-year. This is inevitable under the circumstances, but the effects are only beginning to emerge.

We are seeing a significant number of requests for a quarter’s rent concession from retail and leisure tenants. These range from requests to pay monthly rather than quarterly, to occupiers seeking a rent free period. This has now spilled out to other sectors, with industrial based tenants requesting similar concessions, particularly those supplying restaurants and high street stores. Hotel operators are another area of concern. Without doubt, some operators won’t survive and we’ve received multiple requests for landlord concessions and assistance. This situation will separate those well-run companies with robust balance sheets from the rest, a matter requiring considerable oversight over the coming weeks/months.

RLAM have been proactive in engaging with our tenants and are trying to take into account the individual circumstances of each occupier, keeping in close contact with managing agents and landlords to gauge the stance others are taking, and understand themes as they emerge.

These risks to near-term income alongside weak investor sentiment, will lead to a sudden re-pricing of UK real estate. It is difficult to judge how far values will fall off the back of limited investor demand, and occupier pressures, combined with record low market sentiment; but it could be dramatic, in both quantum and speed. We would hope that in the short term, rents recover and yield increases reverse, as confidence returns and people revisit shops and leisure destinations – potentially just as dramatically on the upside.

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Investment grade credit

Our focus has been very much on managing liquidity and taking advantage of market opportunities. The tone of the market has definitely improved, with liquidity improving. The Bank of England helped matters, particularly with the bonds that would be bought under the programme (utilities, housing associations).

We do not know how long this will last, but the economy will eventually recover. In retrospect, this could look like an attractive buying opportunity, and we are selectively taking advantage of wider spreads. In the Sterling Credit fund, this included a purchase of Finance For Residential Social Housing, while in the Short Duration Credit fund we have added EDF, Wells Fargo and Investec.

Both funds have underperformed their respective benchmarks to 27 March, primarily reflecting sector selection. The biggest impacts have been exposure to sub-investment grade bonds, overweight positions in banks and insurance and an underweight in supranational bonds. However, both funds are very well diversified, have a bias towards secured debt and have yields above their respective benchmarks.

In both cases it is important to look at the likely incidence of default. The most likely sectors are leisure, travel and those areas most exposed to a decline in discretionary consumer expenditure. Whilst our overweight position in secured debt will not prevent defaults risk it puts us in a better position to achieve a higher recovery rate in case of default.

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High Yield

Market yield spreads have widened significantly across all market sectors and for all grades of credit quality. At the time of writing, current levels are now slightly less wide than their widest levels. These moves have few parallels; the prior week’s moves in investment grade spreads were greater than the spread widening in the whole of the month of September 2008, with returns to suit, and the single day move of 100bps in high yield spreads on 19 March was the third largest single day move ever, behind only 9/11 and the day that Lehman filed for bankruptcy.

Interest rates are likely to remain very low for some time, and growth prospects lowered. While initial market reflections on inflation (especially after the oil price move) were negative, the longer term outlook is far different. Elevated volatility is expected to continue and credit yield spreads are expected to remain wider until confidence is regained but there are already signs of this. Although markets could deteriorate further in the interim, we are well positioned to benefit from a recovery in credit markets when they happen.

We believe the portfolio is robust, with a focus on credit fundamentals; maintaining our medium to longer term philosophy-based approach, resulting in an emphasis on security and income, continues to be the best way of navigating the current environment through to market recovery. However, liquidity management is important; market liquidity across all asset classes is reduced and pricing challenging, and we are focused on maintaining the integrity of the portfolio, including servicing any disinvestments and treating all investors fairly, without changing the fund’s fundamental investment approach.

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Government Bonds

It definitely feels like government bond markets have moved past the ‘shock’ phase in this crisis. Initially yields dived as investors sought traditional safe haven assets. As one government after another stepped in to announce huge spending packages to support domestic economies – most of which were of a scale and depth unlike anything see before – yields on sovereign bonds rose as markets panicked about how the spending might be financed. Central banks subsequently stepped in and confirmed that they would essentially buy this enormous issuance, settling markets, and pushing yields down once more.

For government bonds, this has been a period of almost unparalleled volatility. With the broad mechanisms of spending and funding the expenditure now in place, markets are moving to assess the longer term impact of this.

Inflation is perhaps the first and most obvious consideration: in theory, record borrowing and spending, with interest rates at rock bottom, is a recipe for higher inflation. And given the forecast debt levels, many governments would not be unhappy to see inflation increase and thus decrease the real levels of total debt. But theory doesn’t always translate to markets – we can look at what happened in the wake of the global financial crisis and see that record issuance and QE did not push inflation to dangerous levels. It is still too early to predict what the outcome of these policies will be on markets over the next few years, but having weathered the initial storm, this will be the question increasingly occupying government bond markets.

Cash

Market spreads have widened despite the Bank of England base rate cut to 0.10%. This has been driven by a wider credit spread move in both investment grade and high yield in response to the impending economic recession caused by the COVID-19 global lockdown. The spread widening is less a concern about the credit viability of a company, but more about the likely length of the lockdown and the ability for firms to remain solvent throughout this period.

Our cash funds invest in financial assets issued by global financial institutions. These institutions have received generous support and funding terms through this period to allow them to provide support to ailing companies and individuals alike. This is therefore unlike the global financial crisis which was a bank liquidity crisis. In addition, the covered bonds that the fund owns are also backed by a pool of residential mortgages and throughout this period governments are relaxing conditions to allow homeowners to continue to facilitate their mortgages as opposed to defaulting.

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Responsible Investment update

The COVID-19 pandemic has brought about many profound effects and challenges to several companies and comes as a real test to their corporate governance structures in surviving through this unprecedented time. As of late, we have witnessed a range of actions from dividend withdrawals to abrupt annual general meeting (AGM) cancellations as we approach our busiest time of the year. While these issues continue to trickle down into corporate governance matters, shareholders of these companies are left grappling with what should be considered an appropriate action in their voting outcomes. As we will soon come to realise the full economic fallout from this global pandemic, decisions made now will speak volumes later as we review this period in years to come.

As we approach this voting season, we must be mindful of the challenging circumstances many companies find themselves in. However, we also think this is a time when strong governance practices are essential for protecting investors and savers. Ineffective board oversight stemming from a weak or ineffective chairman, insufficient independent directors, or directors with too many commitments and not enough time, are governance factors that often determine whether companies thrive or fail in a crisis. Companies should not automatically be given a pass to weaken governance standards in the current environment. Our approach will be to continue upholding high governance standards during these turbulent times, while working collaboratively across our business to make sure that we make appropriate voting decisions where companies are truly in distress.

It’s in these circumstances where having an in-house team can be invaluable. No level of automated voting can cope with the rapidly changing circumstances facing companies currently, and the impact this will have on the AGM season and voting outcomes. Companies may need to make temporary changes to their board elections, capital raising activities, or executive pay, and RLAM’s in-house governance experts will be reviewing all voting decisions to ensure we are voting in line with the best long-term interests of our customers.

Finally, we think it is worth noting that the consideration of wider ‘stakeholders’ may be even more critical now than it ever has been, with a number of companies taking desperate measures to reduce costs, shore up capital and limit expenditure. In essence, we need to consider what actions are appropriate as executive bonuses come to a vote this proxy season, especially as we see more workforce redundancies and adjustments taking place. Now is the time when companies need to ‘walk the talk’ in terms of their commitment to being good corporate citizens. We believe those companies that have truly embedded the views and needs of their stakeholders into their business models are likely to be the ones that come out of this crisis on top.

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Performance year to date

Governed Portfolios 

Governed Retirement Income Portfolios

Underlying Funds

 

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Longer term performance

Please see our latest performance.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.

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Previous updates

Governed Range update from Lorna Blyth, Head of Investment Solutions, Royal London Intermediary

"Year to date returns across the portfolios have fared slightly better this week although all remain in negative territory. The biggest faller has been equities with the UK market significantly underperforming overseas markets. This is largely due to the UK having higher exposure to energy and mining sectors, consumer goods and banks, all of which have been hit hard. We have also seen double digit negative returns from commodities and high yield. On a more supportive note UK government bonds have delivered positive returns since the start of 2020 with long dated outperforming short dated, whilst property returns have been flat. These returns remain within the range of scenarios we model as part of our governance and oversight process for the Governed Range. We continue to follow our enhanced monitoring process throughout this period and are holding regular calls with senior leaders across the Royal London group and the investment management teams at Royal London Asset Management. This allows us to monitor market reaction, the impact on our investment strategies, customer behaviour and cashflows. We will continue to keep a close eye on economic indicators and market sentiment factors which inform our models and review any impact on our longer-term assumptions. Rest assured that if these are triggered, we will take action to adjust our strategic asset allocations which set the guidelines for our tactical positions. This will be done through our governance process and will follow recommendations from our Investment Advisory Committee. The portfolios remain well diversified across a range of asset classes and as long-term investors we are well placed to take advantage of the buying opportunities when the time is right.“

Please note that this is a fast-moving environment and markets and impacts on portfolios are changing. Opinions contained in this document represent views of our fund managers at time of writing.

 

Governed Range investment activity

Stock markets have bounced sharply this week, after a violent sell-off earlier in March, with more optimism on counter measures to mitigate coronavirus related damage to the global economy, now that the USA has approved a $2 trillion dollar package; however, uncertainty over both the depth and duration of the health and economic crisis remains high.

We have managed equity exposure lower as risks clearly grew rapidly and changed in this crisis. Markets had been expecting a virus problem largely contained in China but now, Europe is the epicentre and the USA has a growing issue. Added to that, oil markets have been thrown in to turmoil with Saudi Arabia and Russia increasing supply, weakening prices substantially. Other commodities, such as industrial metals, have suffered with expectations of slowing global growth or recession. Even gold has not been as resilient as some expected. We have been consistently underweight commodities, offsetting some of the impact of being overweight equities earlier in the year.

We are broadly neutral in equities but have not gone underweight as investor sentiment is extremely depressed – more so than in the Lehman crisis of 2008 according to RLAM’s proprietary indicator; valuations are more attractive and a broad range of monetary and fiscal stimulus measures have been announced. We remain moderately overweight US equities (including the tech sector) given the relatively defensive nature of the market and emerging markets, potentially a safer haven as the virus appears to be under control in China. We are underweight UK equities, a long-term underperformer hampered by a heavy resource sector weighting. We remain overweight high yield bonds, particularly short duration high yield, as we expect the asset class to be resilient over the medium term. We remain broadly neutral on UK commercial property where we have seen diversification benefits relative to equities. We have de-risked our currency positions, remaining short the economically-exposed Australian dollar and more recently moving short sterling while shifting in favour of the more defensive US dollar and Japanese yen.

 

Market outlook, Trevor Greetham, Head of Multi Asset Funds, Royal London Asset Management

"Equity markets may fall further as the virus is spreading rapidly in the US and Europe and forced selling is still in evidence. However, a sharp rally should not be ruled out.

We have a broadly neutral tactical view on equities at present. There will be very pronounced economic weakness in major economies in the near term and unemployment is rising sharply in Europe and the US. However, we have not gone underweight because investor sentiment is already very depressed according to our proprietary sentiment indicator, valuations are also more attractive and a broad range of monetary and fiscal stimulus measures have been announced that should boost the eventual recovery.

We may not yet have seen the lowest point in equity markets as the virus is spreading rapidly in the US and Europe and forced selling is still in evidence. However, we have not been surprised to see a sharp rally as these are common in “bear markets” with volatility very high.

More sustained recovery will probably have to wait until there is more confidence on the virus being under control globally, shuttered parts of the world economy are re-opened and consumer confidence rises from its lows. We expect our Investment Clock model to reflect this situation by moving quickly into disinflationary Reflation before moving sharply upwards into Recovery when the crisis ends. We intend to make full use of our active tactical asset allocation risk budget to add to equity exposure when we judge the time is right.

Our investment process has weathered difficult markets in the past and we added significant value over the 2007-9 Global Financial Crisis. We believe a disciplined and active approach to both risk control and tactical asset allocation will be crucial in portfolios, as markets respond to the current crisis and policy responses being implemented."

 

Royal London Asset Management Economic Viewpoint

According to the BBC, a quarter of the world’s population are now in lockdown… and we are seeing a steep hit to global economic activity with it. Over the week, we’ve had data which helps clarify the scale of that hit, but also more policy measures designed to try and stop this sharp shock becoming a prolonged slump.

The economic outlook still depends on the path of the virus and the efficacy of social distancing measures. But, it also depends on the ability of the banking system, household finances and business finances to get through this in the kind of shape that means the economy can fire up again once the virus numbers ease and social distancing measures can be unwound. That’s where economic policymakers come in. Across major economies, the speed and scale of the policy response remains remarkable.

Data making the scale of near-term economic damage clearer: Recent high frequency data show activity like restaurant bookings have fallen precipitously in the US and Europe. The impact of the virus is starting to show through in business survey data which have sunk to levels similar to those seen during the financial crisis.

We are also now seeing evidence of steep increases in unemployment too, particularly the astonishingly large jump in US initial jobless claims data. In the UK, we know that there has been a big rise in the numbers of people applying for Universal Credit.

More and more economic policy support: Notable recent policy measures include the large ‘phase 3’ US fiscal package (nearly passed at the time of writing) and more measures from the Fed. We have seen a step up in the euro area’s fiscal response with, for example, another sizeable package announced in Italy and a large stimulus package passed in Germany.

Looking across packages and central bank responses, it is again important to note that these are performing multiple functions, in different and complementary ways, working to try and limit long-term damage to the economy. Looking at the $2trn US fiscal package for example, that includes:

  • Direct cheques for households and a large increase in unemployment insurance that will help shore up household finances and provide significant help to get through this period. That then can support consumers’ ability and willingness to spend when the recovery comes.
  • There were also measures to support employers, including a large small businesses loan program, where these are more like grants if used to pay wages/other necessary expenses.
  • There was also money for the Treasury that can backstop Fed facilities (which now include corporate bond buying, for example).

 

Market view from Piers Hillier, Chief Investment Officer, Royal London Asset Management

"History was made this week when the US Congress approved a $2 trillion stimulus package to save the US economy. It is the largest congressional bailout in US history, dwarfing the $800 billion rescue package that was passed in response to the global financial crisis. The bill includes such measures as $1,200 payments to taxpayers earning up to $75,000 a year (plus $500 per child), a substantial expansion of jobless benefits and funding for businesses that have been hit by the coronavirus.

Global stock markets rallied strongly in anticipation of the fiscal stimulus. The Stoxx Europe 600 recorded its third best day ever and the Dow Jones Industrial Average had its biggest one-day rally since 1933, as Wall Street posted consecutive days of gains for the first time in more than a month. Risk assets within fixed income also fared positively, with the high yield market recovering from some of its losses.

As has become normal in markets recently, however, the positive sentiment was short-lived. Markets faltered as investors questioned whether the $2 trillion package would be enough to compensate for a shutdown in major parts of the economy that might last for months. Reflecting the severity of the situation, it emerged that the seasonally-adjusted number of Americans filing for unemployment benefits in the week ended 21 March had risen to a record 3.28 million.

Economists had been expecting a rise in jobless claims of between 1.5 and 2.5 million, already far in excess of the previous high of 695,000 set in 1982. Last week US Treasury Secretary Steven Mnuchin had warned of unemployment rates of 20% without government intervention. These numbers, reminiscent of the Great Depression, are a far cry from the record lows that we have become accustomed to seeing in recent years. The US dollar resultantly sold off, global stock markets gave back some of their gains and the safe-haven 10-year US treasury yield declined.

Meanwhile, Andrew Bailey was thrust into his first ever scheduled meeting as governor of the Bank of England; last week the Bank had an unscheduled meeting in which it cut interest rates to a record low 0.1%. While there was no further interest rate cut this time, in line with expectations, Bailey warned about the economic and financial risks posed by the coronavirus and said that the Bank stood ready to provide liquidity and/or asset purchases in times of stress.

As I said last week, liquidity is everything right now – liquidity for underlying companies as they try to cope with revenues falling by anything up to 100%, liquidity in investment markets, and liquidity within daily dealing funds. One positive effect of the policy responses we have seen is that markets are, if not calmer than last week, at least less volatile, and therefore liquidity in credit markets is better than it was. Our active fund managers will continue to focus on liquidity until we are in more normal conditions as we know we still have a long way to go in getting through this crisis.

As with many businesses across the country, we are operating almost exclusively from our homes, with just a handful of key staff still coming into our offices each day to safeguard certain essential tasks. This presents challenges but years of disaster recovery planning and preparation means that we have been able to do this with a minimum of disruption. Our objective remains to deliver the investment outcomes we promised, and we remain fully committed to delivering this during this very difficult period."

 

Equities

When considering the longer term outlook for the stockmarket, nobody really knows what the future holds yet, as we are very much in unchartered territory. On one hand, the coronavirus and economic news flow is terrible in the short term, and a recession in the second quarter feels inevitable. However, in a prompt reaction to the unfolding situation, there has been an enormous and unprecedented policy response from both the UK government and governments in other developed economies. We have seen a real blitzkrieg of monetary and fiscal policy responses, in keeping with the ‘war’ on coronavirus.

Valuations are optically very low by historic standards, but these numbers can’t be believed and we have no clarity yet on which companies will survive after the temporary government support is ultimately taken away. My view is that the death rate from COVID-19 is not so high that there is an existential threat to the way of life in developed economies. Humanity operates in groups, not in isolation. Life is just temporarily on hold. However, it feels clear to me that things will never be quite the same again – for instance, will global air travel ever come back fully? Equally, there will eventually be reasonable ‘herd immunity’ from coronavirus and some form of immunisation will probably be developed to lessen the impact from future attacks and viral mutations of coronavirus.

Governments worldwide need to build a bridge from where we were economically immediately pre coronavirus to the post coronavirus economy. The initial policy responses we have seen so far are all part of this. The cost of building these bridges will mean much higher government debt levels than have hitherto been the case, except in the immediate aftermath of world wars. When the dust settles, I suspect most companies that have historically prioritised dividend payments will quickly return to paying regular dividends, albeit the quantum may be rebased in some cases. Equity in business has a cost of capital and that is expressed through dividend payments. History teaches us that companies who thrive longer term have capital discipline in their DNA.

Given the scale of government indebtedness, interest rates look set to remain at rock bottom levels for the foreseeable future and yield curves will be heavily managed by governments. Equity investment combines a number of attractive features, such as good liquidity, inflation hedge and income, and therefore will remain an important asset class for investors, albeit one that can be volatile.

Within the active global equity funds RLAM are positioned with lower financial leverage than the index and believe that this will be increasingly important over the next few weeks as some business struggle to generate cash in the current crisis. While market swings are violent there remains good liquidity in large cap equities and RLAM continue to look at further recycling capital into those stocks that have over reacted based on flows or forced sellers.

 

Property

The RLP Propery Fund was suspended on Monday 30 March 2020.

Sentiment in the real estate sector is contingent on many factors, but the underlying health of the economy plays a fundamental role.

A significant slowdown is now underway. Prior to this crisis, values of retail properties were already in decline, with the other main market sectors stable or rising, off the back of the December General Election result. However, across most sectors we now expect to see an increase in property yields and for asset valuations to fall, as a combination of investor uncertainty and near term occupier stress take hold. RLAM are no longer proceeding with a number of investment transactions and expect others to take stock and pause, whilst the ramifications of this global crisis become clearer.

Investment volumes will therefore be suppressed. There are signs that some private equity funds are still active and seeking opportunities, particularly in the industrial sector. Recent deals saw transactions completed last week achieve, and even exceed, asking prices. This demonstrates the view that despite current uncertainty, key industrial locations could benefit from the growth in online and last mile logistics. However, we expect these types of deal to be in fairly short supply.

As social distancing intensifies following the government’s soft lockdown approach, the effects are already beginning to appear in economic indicators. One recent example, particularly pertinent to the property sector, saw this week’s statistics indicating that certain London retail destinations have seen a 90% decline in footfall year-on-year. This is inevitable under the circumstances, but the effects are only beginning to emerge.

We are seeing a significant number of requests for a quarter’s rent concession from retail and leisure tenants. These range from requests to pay monthly rather than quarterly, to occupiers seeking a rent free period. This has now spilled out to other sectors, with industrial based tenants requesting similar concessions, particularly those supplying restaurants and high street stores. Hotel operators are another area of concern. Without doubt, some operators won’t survive and we’ve received multiple requests for landlord concessions and assistance. This situation will separate those well-run companies with robust balance sheets from the rest, a matter requiring considerable oversight over the coming weeks/months.

RLAM have been proactive in engaging with our tenants and are trying to take into account the individual circumstances of each occupier, keeping in close contact with managing agents and landlords to gauge the stance others are taking, and understand themes as they emerge.

These risks to near-term income alongside weak investor sentiment, will lead to a sudden re-pricing of UK real estate. It is difficult to judge how far values will fall off the back of limited investor demand, and occupier pressures, combined with record low market sentiment; but it could be dramatic, in both quantum and speed. We would hope that in the short term, rents recover and yield increases reverse, as confidence returns and people revisit shops and leisure destinations – potentially just as dramatically on the upside.

The RLP Propery Fund was suspended on Monday 30 March 2020.

 

Investment grade credit

Parallels with the global financial crisis are obvious, but perhaps the key difference we’ve seen is the speed at which this happened, with the sell-off all concentrated in almost two weeks as opposed to gradually over a couple of years. The speed of response is also very different.

This week the focus has been very much on managing liquidity. The tone of the market definitely improved later in the week, with liquidity improving. The Bank of England helped matters, particularly with the bonds that would be bought under the programme (utilities, housing associations).

No one knows how long this will last, but the economy will eventually recover. In retrospect, this could look like an attractive buying opportunity, and RLAM are selectively taking advantage of wider spreads in the number of portfolios.

The main focus in these markets is liquidity, making sure there is capital in the funds to meet any client demands or to take advantage of opportunities.

 

High Yield

The unfolding Covid-19 situation is having a major impact on high yield markets particularly the energy and leisure sectors which were the first to suffer as concerns regarding the coronavirus spread and oil supply issues increased. As the severity of the situation became more evident, the sell-off extended across nearly all asset classes and sectors. The largest detractors were driven by cyclical and leisure credits as well as the most liquid credits. The leisure and cyclical credit declines reflect the first order impact of the corona virus on demand and growth concerns. With respect to liquid credit, volatility increased markedly largely due to investors seeking to fund liquidity needs. RLAM are comfortable with the holdings and the team is constantly reviewing the liquidity and credit profile of these as the situation develops globally. They believe the sell-off in high quality liquid credit will create opportunities.

 

Government Bonds

Cash

As the COVID -19 virus continues to spread across the globe, we have seen significant action from central banks and governments globally. The amount of stimulus that has been made available to organisations around the globe is extraordinary. The interesting aspect is that when markets initially continued to deteriorate, the response was to stimulate further with the UK government going as far as backstopping the entire UK workforce (self-employed excepted as at time of writing). In the last 24 -48 hours, despite the UK lockdown, we have seen some encouraging signs from China, Wuhan and even Italy in the control of the virus. This news, combined with the stimulus, is starting to help markets find a base and in the last few days market liquidity has improved slightly.

 

Performance year to date

Governed Portfolios

 

Governed Retirement Income Portfolios

Underlying Funds

 

Longer term performance

Please see our latest performance.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.

Lorna Blyth, Head of Investment Solutions, Royal London Intermediary provides an update on the impact of recent market events on the Governed Range.

"Since our last update on 13th March we have seen further falls across the asset classes in the Governed Range, the only exception to this is Property which has remained stable. UK gilt yields rose from a low of 0.09% to 0.80% making this one of the most volatile periods in the UK gilt market that most of us have witnessed. The sharp rise in yields is linked to the enormous spending commitments being made by the Government to support the economy through this period. These ‘bridging costs’ are almost impossible to calculate as we don’t yet know how long it will take for the economy to get back on a firm footing. As these policy measures work through the financial system we should start to see some stability return but until then markets will remain highly volatile and there is no doubt we are in unprecedented times. The portfolios remain well diversified across a range of asset classes and as long term investors we are well placed to take advantage of the buying opportunities when the time is right."

Governed Range investment activity

The multi asset portfolios went into the coronavirus crisis with a positive position in equities based on broadening signs of recovery in the world economy early in 2020. Stock markets, especially in March, have dropped sharply as counter measures to slow the global Coronavirus outbreak force a sudden decline in economic activity; uncertainty over both the depth and duration of the crisis is high. RLAM have managed equity exposure lower, after buying during the initial sharp sell-off, and have been selling since the Fed’s emergency interest rate cut as risks had clearly grown and changed. The markets had been expecting a virus problem largely contained in China but now, Europe is the epicentre and the USA has a growing issue. Added to that, oil markets have been thrown into turmoil with Saudi Arabia and Russia increasing supply, weakening prices substantially. Other commodities, such as industrial metals, have suffered with expectations of slowing global growth or recession. Even gold has not been as resilient as some expected, falling sharply last week. The portfolios are underweight commodities, offsetting some of the impact of being overweight equities earlier in the year.

With sharply increasing uncertainty and resultant volatility, the portfolios hold a small overweight in equities but have not gone underweight as investor sentiment is extremely depressed – more so than in the Lehman crisis of 2008 according to RLAM’s proprietary indicator; valuations are more attractive; and a broad range of monetary and fiscal stimulus measures have been announced. The portfolios remain overweight US equities (including the tech sector) given the relatively defensive nature of the market and Emerging Markets, potentially a safer haven as the virus appears to be under control in China, and are underweight UK equities, a long term underperformer hampered by a heavy resource sector weighting.

The portfolios hold an overweight position in high yield bonds, particularly short duration high yield, as the asset class is expected to be more resilient than equities over a temporary period of economic weakness. There is no change to the property weighting which remains broadly neutral due to the diversification benefits relative to equities.

Market outlook, Trevor Greetham, Head of Multi Asset Funds, Royal London Asset Management

"Equity markets may fall further as the virus is spreading rapidly in the US and Europe and forced selling is still in evidence. However, a sharp rally should not be ruled out.

More sustained recovery will probably have to wait until shuttered parts of the world economy are re-opened and consumer confidence rises from its lows. The Investment Clock model is expected to reflect this situation by moving quickly into disinflationary Reflation before moving sharply upwards into Recovery when the crisis ends. We intend to make full use of the separate risk budget for tactical asset allocation to add to equity exposure when they judge the time is right.

Our investment process has weathered difficult markets in the past and added significant value over the 2007-9 Global Financial Crisis. At these times a disciplined and active approach to both risk control and tactical asset allocation is crucial as markets respond to the current crisis and policy responses being implemented."

Piers Hillier, Head Chief Investment Officer, Royal London Asset Management provides an update.

"In another extraordinary week for financial markets, central banks were prompted to take actions not seen since the height of the global financial crisis. The US Federal Reserve surprised investors on Sunday by cutting its benchmark interest rate by a full percentage point to zero and reinstating quantitative easing.

Far from reviving markets, however, the actions preceded the worst day for the S&P 500 since 1987’s Black Monday crash. The VIX index, the Chicago Board of Exchange’s famous ‘fear gauge’, jumped to a record high. The lockdowns on the global economy aimed at containing the spread of the coronavirus were the more important concern for investors.

Central banks consequently ramped up their efforts to restore liquidity and confidence in markets. Yesterday the European Central Bank pledged that it would buy an additional €750 billion of bonds, while the Bank of England pledged £200 billion and dropped its base rate to a record low of 0.1%. This morning Norway’s central bank slashed its interest rates 0.75% to an all-time low.

These actions have been more successful, sending eurozone bond yields lower and boosting global equity markets. At the same time, oil prices have recovered somewhat over the past two days on hopes that the dispute between Russia and Saudi Arabia will be alleviated by the US, and the rapidly appreciating US dollar moderated slightly after the Federal Reserve expanded its dollar swap lines.

This is, of course, a rapidly moving story. Markets are highly volatile given the huge uncertainties around the coronavirus. The outbreak and containment measures are still at an early stage in Europe, so investors are estimating the impact on the basis of very limited information.

Perhaps the most common questions we see right now around liquidity and volatility. it is somewhat chicken and egg as to whether decreased liquidity results in increased volatility or vice versa – but certainly both are issues right now. As it stands, this crisis is reminiscent of 2008 in terms of volatility, while liquidity is obviously being impacted in parts of some asset classes. However, we are generally able to trade effectively, if a little less easily, as we continue to manage flows both out of and into our funds. We continue to work closely with regulators to ensure that we play our part in orderly market function. All of our funds share a focus on looking for and investing in long-term opportunities, and this is the lens we use when looking at depressed market levels and considering adding to positions."

Equities

The sell-off in equities continued as managers moved to a risk off position, inevitably leading to weaker share prices in the shot term. Markets are focused purely on the potential economic impact and the uncertainty makes it incredibly challenging for many companies at the moment, especially those being forced to close through government action, of which there are many. Within the active UK funds we have seen pressure on UK mid-caps reflecting a higher exposure to consumer cyclicals compared to the FTSE 100. These include retailers, bookmakers, cinemas and restaurants, which are all being forced to close. There are some signs of dividend yield cuts although RLAM believe that these could be temporary short-term moves, if coronavirus gets under control quickly.

Property

The impact of coronavirus has caused some valuers to add valuation uncertainty clauses into their valuations and this in turn has caused some high profile property funds to suspend trading. RLAM’s view is that the messages from the market are mixed rather showing a downward trend. The biggest impact is likely to be felt in the hotel, leisure and retail sectors. In particular, the retail sector which is already undergoing structural upheaval with many retailers rationalising store numbers in the face of online competition and weak sales growth. Any form of recession will place more pressure on beleaguered operators and could exacerbate failures. The fund remains overweight in office and industrial sectors which is expected to be more resilient with tenants better able to ride the storm and underweight retail. We maintain good levels of liquidity within the fund and have thousands of new and existing customers investing money into the property fund every day. The current market conditions will provide us with opportunities to buy assets which should perform well in the long term. In a low yield environment, real estate income could look more attractive, and London is competitively priced in relation to other major world cities.

Investment grade credit

This is on a par with the global financial crisis of 2009 in terms of the breadth and extent of market volatility. Credit spreads have increased dramatically from 1.1% to over 2% in a very short space of time.

This has obviously had an impact on portfolios. Consumer sectors such as tourism and leisure have been badly affected, but we do not have a high exposure to these. The other area badly affected is energy, but again, this is not an area we have a high exposure to.

We do have a larger exposure to financials. These are not the epicentre of the crisis as in 2008, but are still responsive to changes in consumer behaviour, and hence the likes of subordinated and junior debt have widened by more than we’ve seen in other areas

Secured bonds have generally done well – at least compared to the wider market. We like ABS and collateralised bonds as we feel you get greater protection but don’t have to pay a premium for that, and this insulation has helped.

One area of surprise was short dated credit. Traditionally this is a source of liquidity in stressed conditions, but this has not been the case this time.

Looking back at 2008 and implied defaults, the sell-off suggested defaults would be higher than any other time bar perhaps the Great Depression. Current implied default rates are not at those levels, but are obviously elevated – everyone knows that these will rise from current levels given the economic impact of the virus, but it is too early to predict exactly how much. In our view, this is where credit analysis provides some comfort, as we know the business models and financial strength of the underlying companies.

Credit markets are less liquid than they were three weeks ago. There are several reasons for this, for example as investors sell (relatively) strong performers such as credit to buy equities, while regulatory changes mean that investment banks provide less liquidity than they did a decade ago. In our view, diversification across sectors and issuers is a key element in risk management, alongside our bias on secured bonds and emphasis on income generation.

High Yield

It is still an orderly and functioning market, not like 2008, but it is certainly not easy. The main difference is the speed of decline. Spreads moved wider gradually ahead of Lehman. We have now gone from the tightest to the widest levels in the month, the worst month ever for high yield. This is also different because it is not a credit crunch.

The big difference from then is that we have much more functioning capital markets. Despite the 1000 point spreads, markets are still trading and we have been able to trade where needed. After Lehman it was impossible to trade anything for months.

We have a lot more confidence this time that a lot of our credits will survive because the companies are much bigger now, compared to 10 years ago. The typical structure back then was one bond with a few hundred million and very few options. Now they are much bigger with many options, they don’t need to survive that long for the market to give them the benefit of the doubt. We don’t think defaults will be anything like the market is predicting.

Government Bonds

Over the course of the week we have seen significant volatility in government bond markets, unlike anything we have ever seen. RLAM take some comfort from the extent and coordination of monetary and fiscal stimulus, which is arguably greater than during 2008. However, they are mindful that this will mean much higher levels of government debt which is feeding into government bond market volatility as investors try to assess what this means. This could be a significant long-term economic inflection point – with trends such as globalisation challenged and even reversed.

The government funds have generally been running neutral duration and so volatility of performance has been low versus the benchmark. The main areas that have impacted performance have been those funds which have exposure to AA rated corporate bonds. These spreads have widened which has had the largest impact on performance for some gilt funds. RLAM have been tactically trading duration to mitigate the impact of spread widening where possible and most of the gilt and index-linked government bond funds are at or around benchmark on a year-to-date basis. The Absolute Return strategy had a strong start to the year but has given back some performance in the last few weeks. It nevertheless continues to provide good diversification versus bonds and equities in this environment.

Listen to the RLAM Fixed Income market recorded on 18 March by Jonathan Platt, Head Fixed Income

Performance year to date

Governed Portfolios 

Governed Retirement Income Portfolios

Underlying Funds

 

Longer term performance

Please see our latest performance.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.

 

 

Lorna Blyth, Head of Investment Solutions, Royal London Intermediary provides an update on the impact of recent market events on the Governed Range.

“We have experienced significant market moves over the last few weeks which we expect to continue in the short term. Whilst this uncertainty is a serious concern we can confirm that these scenarios remain with the ranges we model as part of our governance and oversight process for the Governed Range. Our view is that the diversified nature of the portfolios are a benefit during times of market stress and provides us with the flexibility to respond and adapt to opportunities as they arise. We are following our enhanced monitoring process throughout this period and are holding regular calls with senior leaders across the Royal London group and the investment management teams at Royal London Asset Management. This allows us to monitor market reaction, the impact on our investment strategies, customer behaviour and cashflows. We will continue to keep a close eye on economic indicators and market sentiment factors which inform our models and review any impact on our longer term assumptions. Rest assured that if these are triggered we will take action to adjust our strategic asset allocations which set the guidelines for our tactical positions. This will be done through our governance process and will follow recommendations from our Investment Advisory Committee. “

Governed Range investment activity

Our multi asset portfolios went into the coronavirus crisis overweight equities in view of broadening signs of recovery in the world economy early in 2020. Stock markets have since dropped sharply as counter measures to slow the outbreak resulted in a sudden decline in economic activity and uncertainty over both the depth and duration of the crisis. We have managed equity exposure lower, buying during the initial sharp sell-off and selling after the US emergency interest rate cut a week later when markets bounced. Since then we have been selling rallies but we retain a small overweight in stocks as investor sentiment is extremely depressed – more so than in the Lehman crisis of 2008 according to our proprietary indicator; valuations are more attractive; and a broad range of stimulus measures has been announced.

We were neutral commodities when the oil price fell on supply disagreements between Russia and Saudi Arabia. We remain overweight high yield bonds, particularly short duration high yield, as we expect the asset class to be more resilient than stocks over a temporary period of economic weakness. We remain broadly neutral on UK commercial property where we see diversification benefits relative to equities.

We will continue to manage risk over this volatile period by selling rallies and buying again when sentiment is depressed. We may not yet have seen the low in equity markets as signs of the virus spreading across Europe and the US are likely to dominate the news. However, we expect a sharp recovery later in the year when shuttered parts of the world economy are re-opened and consumer confidence picks up again.

RLAM’s investment process has weathered crises before and did well over the Global Financial Crisis. We expect this shock to be more short-lived than in 2008, with an eventual strong bounce back in economic activity and an active approach to tactical asset allocation will be crucial. When recovery comes, it is likely that RLAM will add to equities again due to the additional stimulus in the system.

Piers Hillier, Head Chief Investment Officer, Royal London Asset Management provides an update.

“Stock markets have declined sharply in reaction to the containment measures designed to delay the spread of coronavirus. This demand shock has developed so quickly that it’s hard to estimate the impact on the economy or the depth of the downturn, economic indicators show the global economy may have already brushed recession thresholds. In our view, the virus’ spread, alongside containment measures, will elongate this global downturn to at least a two quarter period for the global economy. While China’s production is coming back on line, weaker demand from the West now also threatens China’s recovery. To prevent a full scale global recession, policy responses are key. While containment measures can help fight the spread of the virus, economic policy can help mitigate the economic impact, ease financial conditions and prevent longer term damage to a country’s productive potential. We are seeing such policy support step up.

Last week we saw a wide array of policy measures announced, adding to the rate cuts from the US. This has included more funding for tackling the virus itself (e.g. for health services or vaccine research), more outright stimulus in the form of additional quantitative easing from the European Central Bank and the 50bp rate cut announced by the Bank of England, and more ‘bridging’ measures to help companies, and households, access funding and reduce their costs as cashflows become challenged during this outbreak. These measures can help prevent significant long-term economic damage, including companies having to permanently lay-off workers. Examples in the past week include enhancing the government-subsidised short-time working scheme in Germany and the UK government refunding the cost to SMEs of providing employee statutory sick pay (related to COVID-19). We’ve also seen the announcement of facilities like the UK’s new term funding scheme, from the Bank of England (BoE), which includes additional incentives for banks to lend to SMEs.

This crisis clearly has some way to go, but global policy action is already substantial and taking place before the impact of the crisis is even visible in the data of many major economies. That bodes well for the eventual recovery.”

Equities

The abrupt sell-off over the last couple of weeks has wiped out the positive equity market returns gained during 2019 and the start of 2020. Market losses were led by the energy sector which fell almost 30% in the week following the Saudi Arabia decision to increase oil production. Financials were also pressured, with earnings power diminished by rates cuts and the risk of loan losses increasing.

Markdowns in markets have shown limited discrimination, likely being driven by program trades. This gives the fund managers in our active strategies’ opportunities to stock pick using their bottom up investment process. Positions were moved more defensive when the downturn started and following some extreme price movements exposure to cyclicals were added. Generally, the active equity funds are positioned with lower financial leverage than the market and this will be increasingly important over the next few weeks as some business struggle to generate cash in the current crisis.

While market swings are violent there remains good liquidity in large cap equities and the fund managers have added to positions following any sell off.

Property

In terms of the implications for the UK commercial property market, it’s still premature to draw strong conclusions about the virus’s impact and so far, we have seen minimal impact. Direct property is not subject to the same volatility as the stock market and it tends to be slower moving and rental income doesn’t swing wildly from day to day.

As an asset class, property is inherently illiquid in comparison to the stock market. Transactions take considerably more time to complete and valuations are less frequent, typically monthly or quarterly. Certainly, if the virus has a sustained and material impact on the broader economy, it will have feed-through impacts on property as well. We expect to see a significant slowdown in assets being brought to the investment market. Deals are still being completed at present and there remains an appetite for good quality stock, particularly in central London. It is likely that travel restrictions will lead to a temporary withdrawal of overseas buyers from the UK market and we could see domestic investors step in and exploit lower levels of competition. Were the crisis to worsen, sentiment could turn quickly and all positions are being monitored carefully.

The biggest impact is likely to be felt in the hotel, leisure and retail sectors. In particular, the retail sector which is already undergoing structural upheaval with many retailers rationalising store numbers in the face of online competition and weak sales growth. Any form of recession will place more pressure on beleaguered operators and could exacerbate failures. The fund remains overweight in office and industrial sectors which is expected to be more resilient with tenants better able to ride the storm.

Over the longer term the outlook remains positive. In a low yield environment, real estate income could look more attractive, and London is competitively priced in relation to other major world cities.

Investment grade credit

The sterling investment grade funds have generally underperformed slightly in recent weeks. This reflects an underweight position in supranational bonds and an overweight position in subordinated financial bonds (banks and insurance). While banks are not at the epicentre there is fear that the economic impact will have a significant negative impact in the medium term. Partially mitigating these effects, secured bonds have generally performed well, while the underweight exposure in consumer and industrials sectors has also been positive. The funds have minimal exposure to travel and leisure companies and small positions in the energy sector which has been impacted by the fall in the oil price. The exception is the Sterling Extra Yield Fund, which has exposure to a diversified range of oil production and service companies (mainly Scandinavian and UK – with low US exposure). Liquidity is a real focus at times of market stress and this is being monitored closely. The fund managers at RLAM have invested through recessionary periods before and will continue to follow their principles of investing to conserve investor’s capital with a focus on credit fundamentals.

High Yield

The high yield markets have viciously turned in the last few weeks and the funds have declined in value commensurately. Despite the move in markets RLAM don’t expect a decline in quality and believe that over time the risk-adjusted returns will be attractive. This is a market to preserve capital and RLAM’s approach in the credit space should benefit performance. Exposure to travel and leisure companies is small at 2% and this is in companies with robust cash balances which should get them over the next six month period. The fund has less than 2% exposure to the energy sector in issuers who have strong liquidity and refinancing options. The impact on financial confidence will increase as spreads rise and refinancing risk rises and RLAM’s preference for good companies that can refinance even if spreads increase should support performance. Current holdings are robust, there are no liquidity concerns and the funds are being positioned to navigate a short-term liquidity crisis and potential recession over the medium term.

Government Bonds

Over the course of the week we have seen significant volatility in government bond markets, unlike anything we have ever seen. Central banks have been proactive with an emergency rate cut by the BoE combined with a large fiscal package in the Budget. The ECB and Fed also added stimulus through additional QE and further rate cuts. Due to the magnitude of the moves in government bond markets, liquidity has been difficult. We have seen spreads widen in general however due to the average size of our trades and our relationship with investment banks we have been able to trade across all markets at sensible levels in the context of market conditions.

The government funds have generally been running neutral duration and so volatility of performance has been low versus the benchmark. The main areas that have impacted performance have been those funds which have exposure to AA rated corporate bonds. These spreads have widened which has had the largest impact on performance for some gilt funds. We have been tactically trading duration to mitigate the impact of spread widening where possible. Most of the gilt and index-linked government bond funds are at or around benchmark on a year-to-date basis. The Absolute Return strategy had a strong start to the year but has given back some performance in the last few weeks. It nevertheless continues to provide good diversification versus bonds and equities in this environment.

Performance year to date

Governed Portfolios 

Governed Retirement Income Portfolios

Underlying Funds

 

Longer term performance

Please see our latest performance.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.

 

 

Equities

As of 11pm on the 31st January, the United Kingdom were no longer members of the EU and so began the transition period. As a result, February began on a positive note with UK & Global markets continuing to demonstrate strong returns - but this was somewhat short-lived. The belief that the coronavirus was under control was well and truly dashed with the month’s early gains being wiped out in a matter of days. Talks of the virus mutating, suspension of trade and borders closing sent markets into a tailspin. Global markets suffered their worst day in 2 years and UK stocks recorded their worst day in the last 5 years. The overall impact of coronavirus is still a moving picture, and whether this is indicative of a global market slowdown, or just a shock market reaction is yet to come to fruition.

We expect volatility to continue in the coming months with updates from the UK/EU negotiations, as well as developments across the Atlantic in the US Democrat presidential candidate campaigns.

We are still overweight equities in our portfolios and remain broadly constructive on the longer-term prospects for stocks.

Bonds

There has been glimmers of hope for Sterling (£) of late with the prospect of increased government spending as well as a spike in response to Sajid Javid’s resignation mid-month. Consumer goods prices rose for the first time in 6 months in January and with the backdrop of uncertain EU negotiations as well as global concerns such as coronavirus, gilt yields remain low and Investment Grade and Global High yield bonds have gone overall pretty much sideways throughout February.   

We remain overweight high yield and corporate bonds and have reduced our underweight position in Gilts.

Property

2019 has seen a lot of uncertainty in the UK Commercial Property space due to the lack of an agreement over Brexit.  This is reflected in the performance of property year date which has delivered a similar return to cash as rental income has broadly offset capital depreciation.

We’re currently neutral Property in our portfolios but prefer industrial property over retail which continues to slow.

Commodities

In the context of all the volatility described above, investors have been looking to gold as a “safe-haven” investment, with gold returning over 4% in the last month. However, from a higher-level perspective, the coronavirus has had a varied impact on commodities, with agriculture related commodities and oil being hit negatively.

We are neutral commodities within our portfolios.

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.