During our 19 March webinar, David McFadzean, our head of investments, discussed recent events linked to the coronavirus pandemic with Simon Watts, our senior investment analyst. Due to the number of questions asked during the webinar, we have put together this Q&A, grouping questions together where possible, and using the information available at the time.
What do you see as the best safe haven given the unprecedented volatility in the markets? What about gold?
What is your view on gold as a form of portfolio insurance at this time? The gold price has not behaved as one would have expected in the last month. Why not?
Is there an argument to increase allocation to US dollars and gold given the current uncertainty and flight to safety?
We already hold a number of different US dollar denominated investments in our portfolios. However, as we have seen with last week’s drop in the price of gold, down 4.5% on Friday 13 March (its biggest decline since 1983), the best approach is to remain as broadly diversified as possible, instead of focusing our portfolio holdings in just one or two types of investments.
Over short time periods, such as days and weeks, it is extremely difficult to predict what investments will perform well (or not) and by how much they will move in terms of value – moves that are often significant given the speed and nature of the news flow. So, we believe the best safe haven is to continue to spread your investments across many types of assets, companies, currencies, geographies and sectors to reduce the likelihood of one news event affecting too much of your portfolio and stick to your long-term investment focus.
Gold is not an investment that we favour as it doesn’t generate any cashflow/income. This is a negative in itself, but also means it is not easy to value using any of the normal valuation methodologies. This means that there are multiple opinions as to its value e.g. if US$1,500 per ounce is good value, would US$2,000 still represent good value? Not being able to accurately value an investment means it is difficult to know when to buy or sell. Gold has done relatively well in recent months, due to the increasing concerns about the future of investment markets, but suffered very recently when liquidity became the number one priority for investors and many had to sell gold to cover outstanding margin calls on other investments. Here, a margin is collateral that the investor used as a deposit with a counterparty to cover some or all of the credit risk that the investor incurred.
Are you not concerned that the world will go into a large recession now on the back of the virus and therefore we will not see an upside for a considerable amount of time? Back in 2008, I remember you ultimately came out of equities and moved more to cash?
Have any equities been sold and cash is now held?
In 2008, although we did sell down our equity holdings significantly, it wasn’t 100% and it wasn’t all at once. It is also worth noting that when we took that decision, you were able to get an interest rate on cash of 6.25%. So the risk/reward for the decision was markedly different than it is today with interest rates at or near zero.
We also see this scenario as different and so it needs a different response. 2008 was a very different macroeconomic environment to the one we face today. Then the recovery was quite drawn out with regulatory changes required that impacted the financial sector and limited funding for businesses, while governments’ responses focused largely on supporting banks.
This time, we are already seeing that the focus of governments is very much on the end consumer and small businesses with fiscal intervention in the form of tax breaks and holidays, wage support for employers and a myriad of other targeted measures. Meanwhile, central banks have cut interest rates and restarted quantitative easing intended to provide liquidity to banks for onward lending to corporations. Ultimately, we believe the recovery will be V or U-shaped, with the scenario of a long drawn-out L-shaped recovery being much less likely.
We consider our portfolios to be conservatively positioned, and when we look across the portfolios at a high level, our asset allocation has been broadly underweight equities and overweight cash. In addition, our equity funds have performed reasonably in a difficult market. Most have outperformed or are in line with peer funds’ performance, while just one, a specialist in value stocks, will remain in focus as an under-performer.
It is rarely a fruitful exercise to try to ‘catch’ the bottom of the market, and we are aware from significant experience that ‘buying a dip’ may quickly turn into ‘buying a slump’. However, markets are forward looking and try to ‘price in’ the ramifications of the news, and since one of the key determinants of investment returns is the entry price, we took the opportunity to buy a small amount of global equities for our higher risk strategies over recent days. It’s important to note that the amount bought was modest as we believe the distress will continue for some time. Nonetheless, we continue to look for pockets of opportunity and will not hesitate to act on these when we find them.
Does the rout in markets prove that portfolios with high or total exposure to passive investments are a fallacy?
We don’t believe that passive investments are a fallacy. They are usually cheaper than active funds and can play a part in portfolios. We will typically use passive investments where we are investing tactically for a short time (where there is not enough time for an active strategy to play out) or where we are investing in an asset class where we have low confidence that an active manager can outperform after costs. Today, approximately 25% of our portfolios are invested passively for these reasons.
Ray Dalio told CNBC that US corporate losses will top US$4 trillion. Can the markets ever recover from this? Please don’t use the long-term ‘get out of jail’ ticket as an answer.
There are a number of market commentators and pundits providing a difficult mix of what could be very unreliable forecasts that are designed to get news coverage. On the positive side, we are also seeing government responses, such as that of the UK government which pledged measures that will cost 15% of GDP to help support the economy. In the US, we are looking at a package of around US$1 trillion.
At the moment, there isn’t a reliable model on which to base our expectations, so our actions are focused on the news now, working with our fund managers, and leveraging our experience to ensure that we understand what’s behind the market movements and plan accordingly, mitigating risk or using market falls as an opportunity to buy.
We are also staying focused on our investment process, because it is designed to weather such storms, and we continue to believe it is working. We are valuation-focused investors, guided by the principle that the price paid is an important determinant of future returns.
The long-term focus is not a glib response. It’s being used as the current situation, although extremely difficult, is a short-term event. There will be a vaccine developed. Economies will recover – we have already seen some signs of China gearing up its industrial production again – and investor returns will follow. Investing has to keep the long-term as its goal. Every investment statement you read will tell you that investments go down, as well as up, to the extent where you can lose some of your original capital. However, it’s been proven time and time again that it’s time in the market, not timing the market, that yields favourable results.
In your forward looking models, how much worse do you think it could go with reference to medium risk managed portfolio?
Assuming that we get through COVID-19 by the end of summer, what will the recovery look like based on a medium risk managed portfolio?
In your opinion, how long will it take for the markets to recover after the virus peaks and reduces? And the million dollar question, are the markets close to bottom or will the markets continue to drop?
What lessons from previous market crashes can we learn from, and apply here? Or, are there no parallels given the cause of the current market turmoil?
We do believe that there will be more bad news before we start to see good news reflected in the market. There is no vaccine against the virus as yet, and there is a view that countries such as China may see a spike in new infections as the travel bans lift and ‘normal’ daily life begins again.
However, our base case scenario remains that we will get through this. It will be difficult at times, but it should also be relatively short lived, although we don’t have a timeline. Instead, we are looking to focus our efforts on managing portfolios in line with our tried-and-tested investment process/way of managing money. This ensures we take considered decisions in our daily meetings that will not increase the risks for our clients.
Equity and credit markets in particular are already pricing in a huge amount of bad news and that is why we have seen a few buying opportunities in recent days. One thing we can learn from previous events of this nature is that, although valuation dislocations can be quite persistent, eventually common sense returns and asset prices gravitate around fair valuations. Investors who have the capacity and time horizon to stick it out will generally do better than those who cash in their portfolios and then end up buying in again at higher levels.
Do you have ‘trigger points’ for indices where you would consider cautiously reinvesting in equities?
Yes, we have various levels that act as triggers, but these are triggers to prompt a specific discussion in our strategic investment committee as we come close to them, rather than forcing automatic buying or selling activity. They are a useful framework and instil discipline within our process, but they are not a decision-making tool.
How long can central banks and governments sustain this support given the rising level of government debt?
For governments to pay for the support packages will ultimately require increased taxation. What is the risk of “Cyprus haircuts” that involve confiscation of deposits?
We are increasingly hearing statements such as “we will do whatever it takes” being used by many of the central figures around the world, and we are seeing significant action and funding – the UK so far has looked to put forward £350 billion, that’s 15% of GDP, to support the economy. So while the measures announced are already considerable, we believe that governments will not be reluctant to pledge more.
At the moment, there are no publically available plans as to how all this will be paid for, although commentators are already starting to speculate. In the past, some governments have just printed money, usually causing massive inflation, but it is extremely unlikely that this would happen now, at least in the developed world. In the UK, we see much of the money being made available is in the form of loans and so these would ultimately be repaid. Different countries will act differently to see a recovery in their finances to more normal levels, but this can be done very gradually and, for now at least, governments are able to borrow at extremely low interest rates.
The term ‘fiscal interventions’ has been used very frequently in recent days. Could you please explain what sort of measures these could involve?
Fiscal intervention is a collective term for any action by government, usually direct action – and, by way of example, can take the form of infrastructure investments, tax breaks, suspension of business rates, additional benefits for the low-paid or unemployed, government grants etc.
It’s a different response to monetary intervention which refers to lowering interest rates, quantitative easing, or other ways of increasing the amount of money or credit supply in an economy. In many developed economies, such as the UK and the US, decisions on monetary policy are not taken directly by the government, but by an independent central bank such as the Bank of England, European Central Bank or Federal Reserve.
Either or both measures can be appropriate and they each have different transmission mechanisms through which they affect the real economy.
You mentioned “dry powder”, what does that mean?
Dry powder refers to the cash and other very liquid investments (investments that can be sold very easily and quickly) that allow us to buy other investments where we see attractive valuations. It just means we are in a position to react quickly when opportunities are available.
What is the rebalancing exercise that you are referring to here?
The asset allocation (i.e. what percentage of assets are held across the different types of investments) is the major determinant of a portfolio’s risk and return profile. For example, portfolios with a higher allocation to equity typically have a higher expected risk and return. However, as the different types of investments produce different returns over time – periods that are much shorter at the moment than is usual – so the portfolio’s asset allocation changes. To ‘recapture’ the portfolio’s original risk and return characteristics, the portfolio needs to be rebalanced. This is not something that is done automatically and we will always consider whether it makes sense to rebalance in any given situation.
Did you hear Gordon Brown on the BBC Today programme this morning? Do you agree with his view that we aren’t doing enough?
COVID-19 is not a traditional macroeconomic event. Its impact on the economy is going to be quite severe, squeezing both demand and supply chains. We are all on a steep learning curve, including governments. As such, it is difficult to know what is enough and what might be too much.
Increasingly, however, statements such as “we will do whatever it takes” are being used by many of the central figures, and so we are seeing extreme action. We believe governments have heard the message, are scrambling to help those affected as quickly as is possible, and we believe that more measures will come through as are needed, depending on the news flow.
Co-ordination is what is lacking. It requires governments to get together – would you agree? That might calm our nerves…!
We agree that what is needed is globally-coordinated fiscal intervention carefully targeted at certain industries, vulnerable small businesses and individuals through this downturn, and we are starting to see that. For example, in the UK Budget, on 11 March, the government announced grants for businesses and measures to support them, which was coordinated with the 0.5% interest rate cut by the Bank of England. Since then, many more measures have been announced, including a further 0.15% rate cut in the UK. We believe there is more to come and there are regular conference calls between G7 leaders, as well as other government leaders and central bank chairs, to ensure a rapid and substantial response.
In the light of recent extreme currency rate fluctuations, and given that underlying investments are in several currencies, how do you handle currency risks?
As sterling is trading at 30 year lows against the dollar at present, what are your thoughts about sterling increasing in value in the short and longer term, and what measures are you taking to cover this eventuality?
Has sterling reached the bottom? (Versus the USD).
Just like other asset classes, we do not seek to time currency markets and so are not looking to call the ‘bottom’ of sterling. Instead we continue to diversify the portfolios across a range of currencies.
We are seeing significant moves in many currencies, in large part driven by the various announcements on interest rates by central banks. We are exposed to the risk of currency movements in our portfolios as we are global investors, but we manage these risks by hedging an appropriate amount of that exposure, depending on our current view. So we consider currency risk in the context of our overall portfolio management.
One benefit of running global portfolios is that the weakening of some of our sterling positions was offset by some of the other investments we hold. So our sterling denominated investors benefitted from our global approach. It’s important to note that when we talk about global, we really are truly global. The UK only accounts for about 5% of global equity markets and about 7% of fixed income markets. When we hold larger percentages than this, it is an active decision that has to be justified on investment grounds.
Clients of Nedbank Private Wealth can get in touch with their private bankers or relationship managers directly to understand how their portfolios are responding to market events or call +44 (0)1624 645000.
If you would like to find out more about how we can help you manage your investments, please also contact us on the same number as above.
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David is responsible for developing and delivering our investment proposition for private individuals, trustees and investment consultants. He works in partnership with our teams of private bankers in fulfilling our purpose of protecting our clients, advising them with integrity and making their lives easier.
He has over 25 years’ experience working for global blue-chip companies in both London and Jersey, and providing investment solutions to a wide variety of clients around the world. David is a Chartered Fellow of the Chartered Institute of Securities and Investment and a Chartered Wealth Manager