Perspectives in turbulent times

The COVID-19 crisis is affecting economies across the world with education, hospitality, retail, tourism and entertainment sectors majorly impacted by social distancing measures and travel restrictions.

Given the rapidly evolving nature of COVID-19 and its impact on global financial markets, we sat down with three of our specialists to discuss how they're positioning portfolios in light of financial market turbulence and uncertainty. Responses come from:

• Simon Stevenson, Deputy Head of Multi-Asset
• Martin Conlon, Head of Australian Equities, and
  
• Stuart Dear, Deputy Head of Fixed Income
  

Following their views, we also share five sensible steps to protect your investments.

Simon Stevenson, Deputy Head of Multi-Asset

We've had monetary policy stepping up for a little while, but now we're starting to see the fiscal side grow. When I think about the fiscal side, I think about the stages of grief - the denial was the first stage, we've gotten past this now we're actually seeing quite a bit of action.

What are your thoughts on the US in particular?

The interesting thing is when the US Federal Reserve announced two forms of emergency easing and quantitative easing, we saw extreme volatility in markets. I think that reflects the fact that monetary policy is only a small part of the solution.

The solution is fiscal policy. 

And we're starting to see fiscal policy grow. In the US we've seen some packages go through but recently the rumour is that there's going to be exceptionally large packages in the US upwards of 6% of GDP involving cash handouts to households, which we’ve seen in Australia during the global financial crisis can be quite successful.

What do you think about Australia in that context as well?

We've got the monetary response, the fiscal responses are too small at the moment. We’re hearing this more and more from governments that it is like a wartime and wartime budgets are generally around deficits of 10% of GDP if not larger. So that sort of contextualises the size of the responses that probably will be needed.

What's the outlook from here?

We know it's quite extreme so the outlook is really how much the government is prepared to step in to fill that hole. This is quite different to your usual cycle as the usual cycle is where you have an overheating economy, and you have one sector that's going crazy, for example, commercial property in the 80s, IT investment the 90s, houses in the US in the 2000s.

And when you have a recession, the recession lasts as long as it takes for those imbalances to be worked out of the system. When you have an external shock such as the Spanish pandemic, you had a very short, sharp recession, but it was over once the shock passed.

So, the key thing we know, in theory, the shock will move through quite quickly but the effort is how much we keep the economy whole as we move through that.

Should investors be worried about liquidity?

The central banks are running a little bit behind, but they'll start to catch up and provide liquidity. But while we still have the uncertainty about the fiscal response and where we're going we will see some illiquidity, but hopefully that will settle down.

Have you seen buying opportunities or do you think it's too early?

At this point in time, we're not sure where valuations truly are as prices have adjusted but we don't know how much earnings are going to adjust. It's probably a little bit premature. But at some stage it will become clear and we'll have a better idea, and we know in these kind of crisis environments, opportunities do happen.

How have the Schroders multi-asset portfolios held up so far?

The portfolios have held up relatively well. There's several reasons for that. Firstly, we were worried about valuations coming into this so we held out equity levels at a reasonably defensive levels in that we didn't have a lot of equity risk in the portfolio.

We also had a couple of other tools in our toolkit to help manage volatility in the portfolio. We've had foreign currency, we know in times of shock the Australian dollar generally falls and falls quite sharply. So having foreign currency, US dollar in particular, has helped offset some of the losses through equity markets.

Another area in the portfolio that has done quite well is having duration, earning in government bonds in the portfolio, because we've seen bond yields fall quite sharply providing a capital return from that part of the portfolio.

Martin Conlon, Head of Australian Equities

There's a lot going on in markets at the moment and I think what we're really seeing is the epicentre of the move to quant and passive and a lot of those things means that algorithms and computers are doing a lot of the buying and selling at the moment. That is a bit of a consequence of moving away from active management, but it is scaring people in the amount of volatility.

The other things that we probably point to are people clearly running away from the earnings risk in the short term and running towards earning certainty, almost regardless of the multiples that they're playing. And probably lastly, we'd say that balance sheet strength is becoming very important again, having low levels of debt in an environment where there is disruption is hugely advantageous versus being highly geared, the market really is gravitating towards those companies with strong balance sheets.

What is the outlook from here?

We believe that, whether it's governments or otherwise, there'll be a lot of efforts to ensure that businesses can see the other side of this crisis, and they will be around to earn money in the foreseeable future. When you buy a business, you're buying a long-dated cash flow stream, you shouldn't be overreacting to short term earnings. There is a massive overreaction to those short-term earnings directions.

We think the opportunity is very much to look through that, and to be focused well beyond the fact that this will pass at some stage, which is very painful while we're experiencing it, Qantas will not make losses forever. And we do believe that it is highly unlikely that the government are not going to let the country have no airlines. When you are in the epicenter of the storm, you've got to think rationally about what is probable in the medium term rather than reacting too much to what is hitting your face.

What are your views on differents sectors?

Banks - They are at pretty cheap levels historically, they're well capitalised, relative to where they were at the beginning of the GFC so more of that bad news is factored in. So we are sitting on the fence a little bit on banks, but we are cautious that the conditions in the medium term as a result of these sorts of shocks may deteriorate the bad debt front.

Resources - They seem in the short term to have weathered the storm pretty well, and that balance sheet strength to us is a massive advantage. We look at them and say, they look to us to be in great shape, and they are cheaper, that makes us more optimistic not less.

Oil - Cash flows for oil businesses are under pressure, oil businesses with financial leverage are going to be under even more pressure. That said, we still believe that prices probably will recover in the medium term, but they might have to endure a year or two of tougher times rather than just a few months, and that means, focusing on the businesses that are better positioned in a balance sheet context.

Healthcare - Healthcare is a funny one because obviously being healthcare a crisis the immediate reaction of investors is "I want to buy even more healthcare". I would say you should be looking for stocks and businesses that are getting cheaper, not the ones that are getting more expensive off a base that was already expensive.

Consumer stocks, travel and tourism - We are cautious because they tend to be very operationally leveraged and have some financial leverage. There is no doubt a reasonable amount of that sector is going to get into financial distress without support.

How have you been responding in portfolios?

Underweight healthcare - While we don’t have much exposure to healthcare stocks etc that are rising from levels that were already high, we are very well positioned in strong balance sheet business so that is holding us in good stead.

Underweight consumer cyclical - And we have very little exposure to the consumer stocks like airlines, retailers, etc outside the supermarkets which again have done very well. The portfolio’s got very minimal exposure to that consumer end of the market.

Accumulating bulk commodities - In terms of what we’re moving, we've had price falls make business based on more durable earnings look more attractive. 

Accumulating energy - We have put a little bit more into oil and energy given the extent of the price falls and our view is that things will recover in the medium term.

Holding defensives - And we probably have retained on the other side, some of the good businesses that we think are probably more defensively positioned like the Telstra’s, the Woolworths, the Medibank privates etc, that probably have very diverse and different earnings streams that are probably very well positioned to withstand what are going to be a fair number of earnings pressures.

Stuart Dear, Deputy Head of Fixed Income

What’s been happening in your portfolios?

Duration - We’ve been increasing duration in the portfolio particularly by buying US treasuries over recent months and we’ve also effectively neutralized our credit exposure and also, we were short what we deemed to be the most vulnerable part of the credit market, that was US high yields.

Performance, month to date - So, we were well-positioned coming into this, and its meant that our returns have actually held up pretty well because effectively what we’re seen is a scramble for safe assets particularly treasury duration and we've seen credit spreads widen materially, so it’s been a tough time and a for investors, tough time for credit markets within fixed income.

What is the outlook from here?

Policy easing - Well I think we’re moving into a very difficult phase, because what we’ve seen is central banks ease the monetary policy aggressively and we’re just seeing the big fiscal policy response come through now. But we’re still unclear here as to how much economic fallout there will be. We're pretty sure that unemployment rates will go up and businesses will fail.

Industries most affected - The policy support we are seeing won’t be able to save everyone. And we think there’s particular stress in certain industries. There are some obvious examples airlines, energy, discretionary retail, universities are under a lot of pressure. As I said, we don’t think that policy support will be able to save everyone. There will be bankruptcies, there will be defaults, which we want to avoid in fixed income. We’re very confident actually that all the securities we hold won’t be subject to defaults.

How have you been responding in portfolios?

Illiquid markets - I think it’s important to say that markets are really quite illiquid and actually quite dysfunctional. And even the safe sovereign bond markets are hardly tradable, liquidity is extremely thin at the moment. So, while we’ve seen some policy support come, markets are still very dislocated.

Profit-taking - What we have been doing is we’ve actually been taking some profit on our long-duration positions, so selling down some of our treasury exposures, selling down some of our Australian government bond exposures. We think we’ve seen most of the movement in safe sovereign interest rates.

Opportunities present - What we haven’t done yet though is really allocate back to credit. We’re still assessing the opportunity there and we think we’re actually well placed to be able to take advantage of the opportunities that are arising, but we think it’s probably still a little too early. So, we’re being cautious.

Five sensible steps to protect your investments

While negative headlines about the stock market can be off-putting, investors should be grateful for them. Every dollar invested today could buy considerably more shares than it would have done at the start of the year.

1) Don't panic - think long-term

It’s important to make considered decisions when adjusting your investment portfolio. An emotional response will very rarely benefit your savings. By staying invested now you could benefit when the market picks up again.

2) Reassess your attitude to risk

What these episodes can usefully do is prompt a re-evaluation of how much risk we are willing to take. It’s all very well charging into the stock market when it’s been going up for years: these corrections remind us there can suddenly be a downside. Many of us will take some risk in the hunt for higher returns, and there are ways to moderate that risk.

3) Reassess your portfolio

Are you happy with the mix of risk? Check you are happy with the proportion of your savings that are in the stock market as opposed to cash or government bonds, and diversify if you are concerned. Some funds offer ready-made diversification by spreading across asset classes. Do your research. You could de-risk yourself by simply holding more cash in savings accounts but be aware of the effect of inflation versus interest rates.

4) Diversify your exposure to the stock market

Even within the portion of your portfolio that is invested in the stock market, be sure that it is diversified in itself. Some people have pet regions or sectors and over-reliance on them can be a set-up for big losses if things go wrong.

Either diversify yourself or choose managed funds that are themselves diversified.

5) Drip-feed

By investing a regular amount each month you take away a lot of risk – it is the opposite of trying to time the market. In times of stock market falls the amount you invest will be picking up more units. This means you will ride out much of any market volatility.

View the extended interviews with Simon, Martin and Stuart

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