Blue Sky Quarterly Investment Market Update
As promised, I am going to communicate a summary of my conversations with our investment partners, held on Tuesday of this week. I will comment briefly on what has happened, the current dynamics, the actions being taken and each company’s respective outlook for the economy and investment markets.
The companies involved are:
- LGT Vestra
- L&G Investment Management
Please note that when running our internal portfolios, it is essential that we embrace a wide spectrum of views beyond the above companies. However, one of the reasons we began working with LGT Vestra for example, was their research capability and during this crisis, our decision has proved to be a wise one.
There has been a lot of talk over the years as to whether passive index management is the way to go, as it is cheaper and evidence points to out-performance over selected periods, compared with their active fund manager counterparts. However, our view has always been that a blend of the two styles is preferred and there is no doubt that active fund managers and portfolio managers are, in our opinion, adding value at this juncture.
For example, investing in an index like the FTSE 100 is skewed in favour of oil and banking companies. With the collapse of the oil price, avoiding any such related stocks, has lessened the impact on portfolios.
Please find below our Quarterly Investment Market Update as at 3rd April 2020.
The style of this weekly market update
I have a lot of information to hand, but I’m conscious about not over complicating what is happening across investment markets.
As I begin writing this commentary on the 2nd April, the oil price has risen by 12% on hopes that the Saudis and Russians can come to some agreement about limiting the supply of oil. It just goes to show how quickly the dynamics can change.
In the interest of making this update easy to follow, I’m going to plagiarise some of the headings from a recent LGT Vestra report, whilst giving you the thoughts of our investment partners.
I warn you, this is not short because a lot is going on. So, so I suggest a cup of good coffee and a couple of little treats should be on hand when reading this. If you finish this in one go, well done! Are you settled? Okay, I shall begin…
What has happened?
Well, I think we all know by now and I will spend a limited time on this section.
The news flow is alarming but at least now we know what we are dealing with to some degree. How long this will adversely impact our lives though, is the unknown. The support services and frontline NHS staff are rightly applauded, along with the huge commitment given by volunteers.
On the economic front, it is evident that the virus has paralysed economies around the world. The response to the virus has hurt many sectors badly and a report out yesterday, said that one in five of small to medium sized businesses in the UK, have only approximately four weeks capital to keep their operations alive.
Three weeks ago, I don’t think many of us appreciated the extent to which this virus would impact our lives. Initial reports from Imperial College were frightening, but recent reports have given us hope that the number of predicted fatalities will be significantly lower than initially estimated. This is mainly because of the measures introduced by the Government.
The challenge now lies with getting protective equipment to the frontline, equipment to deal with patients suffering from the virus and enough testing across the population, with the emphasis on keyworkers. Undoubtedly, there are issues with logistics, but reports suggest that the aim is to test 25,000 people a day by the middle of April, and by the end of the month; 100,000 a day. Let’s hope so!
Investment Market Response
There was a rapid collapse in equity prices around the world as the magnitude of the virus and its impact hit the western world. Government bond prices rallied, but then came a liquidity crunch where investors wanted access to cash and US dollars (deemed a safe haven). As a result, across the board, all other financial assets sold off.
As a result of the indiscriminate selling, the corporate credit market was hit hard. Central Banks then reacted strongly to provide liquidity to businesses and the markets. We now find interest rates in the UK at 0.1% and the Government, once again, buying bonds to prevent the cost of borrowing rising.
Support is also available for businesses both large and small, although there seems to be some difficulty in accessing the money (if the experience of people I’m speaking to is anything to go by). Finding someone in the bank who can make a decision is not easy and the rates offered by some of the banks is verging on the ridiculous. This money needs to be made available quickly and at a rate which is acceptable.
The Federal Reserve has reduced its interest rate to zero and announced unlimited quantitative easing. They too are buying Corporate Bonds. Measures which, on the whole, are deemed to be more expansive than in the financial crisis, 12 years ago.
The European Central Bank increased its bond borrowing by relaxing some of its previous limits. The Bank of Japan has also acted and has been buying equities.
There are similar stories from around the world. The stimulus has been hugely significant and timely. In 2008, quantitative easing was untried and untested. This time Central banks knew what to do.
We have been talking about fiscal stimulus for some time now, but we didn’t ever imagine it would be delivered in this format.
Whilst the UK Government may be criticised in part as to how they have handled the crisis, to my mind, they acted with stealth in supporting businesses and workers. As LGT Vestra pointed out, having a significant Government majority has enabled them to respond in a timely manner. A contrast to the attrition seen in the US between the Democrats and the Republicans.
The decision to support businesses of all sizes and ensure continued employment has been welcomed across the board. The job retention scheme should see two thirds of businesses take up this lifeline.
Support for the self-employed is more problematic and whilst it helps approximately one third of self-employed, it does leave many out on a limb. Apparently, over 100,000 people per day are applying for Universal Credit.
Similar measures have been taken across Europe; Denmark has been even more generous when supporting businesses and employees with a similar job retention scheme, offering to pay up to £48,000 over a 4-month period. Of course, the cost of living in Denmark is so much higher.
Whist the US lagged every other developed country, with Trump apparently in denial about the seriousness of the virus, they finally delivered with an agreement of a $2 trillion package. This was seen as an important action from the largest economy in the world and drew a line under equity markets, which have since bounced from their low points.
When constructing portfolios, we have been mindful of the possibility that both equities and bonds could fall in value together. This happened in 2018 and in reaction to this crisis it has happened again, although initially bonds proved resilient.
We have traditionally used UK Commercial property, successfully for the most part, as an asset with a low correlation to equities and bonds. With the Brexit shenanigans, we transitioned away from Commercial property due to liquidity concerns, which is just as well, because a whole raft of companies have suspended their funds and now have liquidity issues – worse than what we saw after the EU referendum.
We have moved to using Infrastructure funds instead of Commercial property, with Foresight in particular. The aim being to add an asset class which has a low correlation to the main equity indices and the bond market. We have been delighted with the way both the UK and global funds have performed, until two weeks or so ago that is, when there was indiscriminate selling across the whole investment spectrum. The good news is that they have recovered quite a bit of ground and are now behaving more like we would have expected. More about this below.
We have been encouraging clients who are holding significant amounts of surplus cash to enter the equity market. Choosing an individual stock is fraught with problems, as it’s difficult to know each company’s viability. I appreciate the rewards can be significant, if you are willing to take the gamble and get it right. Getting it wrong can be extremely painful.
Instead, it’s better to access the momentum of the market by buying funds or entering portfolios. We would recommend the latter, for it provides more diversification.
There is much conjecture about whether to buy at these levels or whether to hold off. Our repeated mantra is to buy periodically, because trying to time the bottom of the markets is a matter of luck. However, down the line, when we come out of this turmoil, there will be many stories of “I wish I had bought X, Y & Z when it was so cheap”.
Below are the views of our investment partners:
Whilst equities undoubtedly look cheap, we are not rushing into buying more equities at this stage, but neither are we reducing our holdings. The key in the short-term, as to what represents good value, is dependent upon how long this virus holds us in its grip.
If this only lasts a short while, a matter of weeks, then with the avalanche of stimulus committed by Central banks and Governments, expect to see a humongous rally in the markets. If you like, a V-shape recovery.
If this goes on for a few months, we believe the recovery in asset prices will be more like a ‘tick’ shape, albeit with some good companies struggling to survive.
If this virus hangs about until next winter in the northern hemisphere, then there will be a marked impact economically, with many corporates falling by the wayside. This will be really damaging and sticking with the imagery, it will be more akin to a ‘U’ shaped recovery.
The encouragement is that more and more people are being tested and only yesterday, the numbers of people to be tested, in a few weeks’ time, is muted to be 100,000 people a day.
LGT Vestra’s immediate concern is the United States and their slow response to the virus. How the US copes with the significant increase in cases and deaths will be an important barometer for how we move forward from here.
Of course, Phoebe concurs with Sanjay’s sentiment, but she also spoke about many companies who will have to launch right issues and cut their dividends. European companies, across the board could see their dividends halve. This further reinforces the attractiveness of corporate credit in the short-term. More about this later.
Phoebe spoke mainly however about the Sustainable portfolios she runs. One example of the recent changes to the portfolios, was the sale of BMO UK fund. Some of the proceeds have been invested into bonds and part has been used to buy the Janus Henderson Globally Sustainable fund. This holds companies like Adobe and Microsoft. The main reason for this is that they are likely to weather any supply shock, after the virus has abated.
Phoebe reinforced that they are focusing on well-known, well researched companies, with strong balance sheets who have good cash-flow and low debt. LGT Vestra have stress tested all their models and have contacted all fund managers, to understand their strategies.
Mentioned also, was a purchase in Polar Capital. This has an emerging market emphasis, albeit with 30% in China. With production cranking up to about 90% of capacity in China, this is a good position to take.
Phoebe reinforced the positions across her portfolios. They are as follows:
- Consumer cyclicals
- Health care
- Consumer defensive
I asked the question, as to why there was a differential in performance between the main model portfolios and the Sustainable portfolios lately. This was down to a 10% hedged position on currency, as the vast majority of holdings are overseas. The dramatic fall in Sterling hurt the portfolio in the short-term, but its partial recovery has helped since.
We spoke about inflation and deflation and LGT Vestra have now sold most of their index linked holdings, because they believe there will be a demand shock, despite lower interest rates and a lower oil price, potentially being inflationary. This money has been reallocated into corporate credit.
Finally, Phoebe spoke about an exciting opportunity in the Sustainable space and that is the launch of a Covid bond… doesn’t sound very nice, does it? However, the reality is somewhat different in that its emphasis is on having a strong sustainable and social benefit. Furthermore, it has what is called ‘a use of proceeds’ alignment which means it is clear when you invest, how the proceeds will be used. The African Development Bank and Nordic Investment Bank are involved in raising billions of dollars to make a positive influence. A great example of the financial markets being part of the solution.
So there are opportunities
I’m not talking equities here but an opportunity in the bond space. Yes, the bond space… I didn’t think I would be saying this at the start of the year!
We shouldn’t underestimate the impact of the search for liquidity. It hit most asset classes. I like Sanjay’s example of MasterCard; basically, 6-7 weeks ago MasterCard was trading at a level to their bond of 3.3%. In other words, if as an investor, you held this to maturity, you would receive 1.1% per annum. Higher than the bank deposit rate but far from exciting. Now, if you buy that bond and hold it to maturity, you can get 12% over 3 years. That is 4% per year at a time when bank rates are virtually zero. Attractive indeed, especially when the authorities have underpinned the asset as part of their Quantitative Easing program. In fact, it was stated to me that this is a once in a lifetime opportunity!
It may not be as exciting as equities, but I think we’ve had enough excitement for the time-being! LGT Vestra, 7IM and LGIM have all begun increasing their holdings in this space and this should serve to lower the volatility across portfolios moving forward.
Bonds don’t like rising interest rates and it’s clear that interest rates are now likely to stay low for years to come.
Coping with uncertainty… a perspective.
Blue Sky are continuing to hold reviews with clients, albeit via telephone or video calls. Most clients just want a general chat and a reassurance that they are okay financially. We will continue to contact you in person if a review is scheduled over the next couple of months.
At this juncture, I would like to say a huge thank you to all our clients who have been so understanding, and appreciative of our ongoing communications. We all know the reasons why this is happening, but nevertheless we appreciate how unnerving this situation can be.
We will come out of this and whilst it is truly awful now, as we see the death tolls mount, at some point, we will see this subside and we can begin to feel optimism once again. When this happens, watch your investments surge… remember the markets tend to react ahead of economies.
It’s so important to keep a perspective.
Good things are happening!
Isn’t it great to see so many people pull together to help others in times of need?
I’ve always said that at Blue Sky , it is our culture that defines us. Culture is also so important when identifying who we work with, clients and companies alike.
With this in mind, I was mightily impressed when I discovered that David Scott, The Chairman of LGT Vestra, announced that they have established a fund with the intention of raising £100,000 to contribute to those who are most in need at this time. They have contributed an initial £25,000 already. Great stuff.
Until next week…
If you managed to stay the course and read all this communication, I think you deserve a proper full-blown treat. You will be pleased to know that you won’t get another lengthy script for another 3-months. Hopefully, we will all be in a much better place by then!
Our shorter market updates will be sent out as usual next week.
Gary and the Blue Sky Investment Team
The comments above are Gary’s interpretations of what was discussed.
This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.