I have been in markets for over 30 years, and the first half of 2020 will go down as one of the most difficult environments I have encountered. We had the coronavirus pandemic, we had economies shut down overnight, we had a violent response in markets and finally we had an equally significant policy response, which turned markets around.

Here in Australia, we had policy changes which enabled superannuation investors access to their money. And so superannuation funds that had invested for the long-term, all of a sudden needed to find liquidity and to top all that off, we went from working in the office to working from home basically overnight.

Current risks and opportunities in the market

The way forward is littered with landmines. Even though markets have settled down onto a better path over the last month or two, there are still some major issues out there that we need to navigate, whether that be the path of growth, geopolitics, or a second wave of the pandemic disrupting economies again.

Cash rates and bond yields are extremely low, so those assets offer very limited returns. Central banks have stepped into credit markets, which has suppressed the yield on corporate bonds. For those interest bearing assets, the return outlook looks moderate at best, and there are some risks in parts of the credit market.

Equities have fared relatively well, largely because the interest rate environment has meant that the yield on equities has stacked up well against the more traditional interest bearing instruments. Central banks have flooded markets with liquidity to support that idea, and so I think there's probably more upside potential in equity markets.

The challenge though, is that all those things have been factored into prices, and equity valuations are now starting to look like they're pricing in a much more optimistic outlook than is likely. I think equities probably have the most upside potential from here over the medium term, but in the short term the prognosis is risky.

We are looking at areas like currencies, at assets where there may be some sort of structural risk premium in private markets. I wouldn't underestimate the value of liquidity in this environment, because when volatility reasserts itself, having liquidity will provide us with the opportunities to be able to access good quality assets at much, much better prices. I think that will generate returns for investors over the medium to long run.

Positioning in the current environment

There are some competing issues in markets at the moment. One is the obvious concerns about the global outlook, but that's being offset by the wash of liquidity that has flowed through to support economies and to support markets. And so there's a bit of a tension between significant economic risks and lots of money floating around the system.

We went into the COVID crisis relatively defensive. We cut out equity weights early and have been rebuilding those over the course of the middle part of the year. But as markets have risen, we are now starting to see some of that balancing out. We have started to wind back our risk positioning, and we've pulled roughly half that additional equity exposure out of the portfolio, because we think that markets have run ahead of themselves. We are maintaining liquidity and we have been selling investment grade credit to try and build up our cash levels as we do think there will be another round of volatility. And we'd like to use that to step back into markets again and add risk at much better prices than we're seeing at the moment. 

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