This is not a traditional macroeconomic event. Like almost everyone else, we know very little about this virus and its likely impact on the health of billions of people. There are many people looking at models of infection rates or previous outbreaks and trying to divine what will happen this time. Our investment teams, while using different underlying processes, all look for an information advantage. In times like this of increased information uncertainty, risk management comes to the fore. This is embedded in our underlying investment processes and we test our strategies against historic stressed market events to ensure we understand the impact that these might have and enable us to mitigate unintended risks.
Second, we know that markets are powerful discounting machines, but that they frequently over or under-react. Given the lack of knowledge in this instance, I feel it is impossible to know whether markets have gone too far or not far enough, but that it is almost certain that opportunities are created when markets go into a state of flux. This explains why record falls tend to occur very close to record gains.
Third, it is apparent that we are going to see an economic effect. The outbreak is likely to lead to lower growth as uncertainty about how the crisis concludes has a knock on impact on business and consumer confidence. When confidence is low, saving tends to go up and spending / investment can fall. The counterweight to this is fiscal and monetary stimulus. The Federal Reserve emergency rate cut was not the first such stimulus we’ve seen in this cycle, nor will it be the last. The size of the initial growth shock, and hence the stimulus policymakers feel is appropriate, will not be clear for some time. However, if the experience of previous outbreaks such as SARS or Swine Flu play out, they would suggest that this outbreak probably won’t have a material long term impact on the global economy.
If we look at single asset class portfolios such as fixed income, equities and property, the effect on our activity is minimal. Our processes in these areas all share a focus on looking for and investing in long-term opportunities. This is the basis for the conversations we have had with clients when investing, and making significant changes based on such an uncertain outcome would be imprudent in our view.
In fixed income, this has pushed out the timeframe for the end of the ‘lower for longer’ interest rates period. As outlined above, there may be a short-term impetus to cut rates, helping to keep bond yields low, but the long-term factors that drive our strategic view have not materially changed. In areas such as sterling credit, our focus on bonds that offer an element of security gives us comfort during any period of market turbulence. Liquidity will be an issue in some parts of the market – for instance we have seen the new issue market slow in recent weeks – but we do not expect a significant squeeze. In the short term, high yield remains the most under pressure area, particularly in companies with higher exposure to energy or China, but these are areas we tended to have lower exposure to anyway.
In equities, we tend to have lower exposure to the areas that are likely to feel short-term pain – areas such as travel and tourism, as cashflows in these areas are very sensitive to consumer sentiment, and balance sheets tend to be weaker. We do have exposure to certain industrial cyclical companies which could be affected, but do not feel this is excessive. In the short term, activity in our portfolios is more likely to be using any widespread weakness as an opportunity to add to companies we had already identified. We have already added to some companies at prices far lower than we were seeing two or three weeks ago, and think that this could provide a boost to future returns.
In property, our investment strategy remains focused on prime assets with strong covenants and periods of uncertainty can provide opportunities for long term capital deployment. We had seen a ‘Boris Bounce’ in terms of a significant increase in overseas interest after the general election. However this may fade faster than many expected, simply because overseas investors are now travelling less to view properties. The retail sector and the High Street more generally have already been under pressure from the internet and may face an additional short term impact from the decline in consumer confidence.
Finally, in our multi asset funds, the view is similar. Trevor Greetham covered much of this in his recent webinar. But in the Governed range, this is seen as an environment that lends itself to tactical opportunities rather than a strategic re-weighting. We increased equity exposure during the initial deep market sell-off and reduced again on the rebound. The objective is to manage downside risk while preparing portfolios for the ultimate sharp recovery in growth we expect to see when counter-measures to limit the spread of the virus are reversed.
For more information please visit our Investment Clock webpage or contact your usual Royal London sales consultant.