Coronavirus: the views from our investors
Coronavirus: the views from our investors
Emerging market equities
Tom Wilson, Head of Emerging Market Equities:
“The virus is becoming more widespread and increasingly hard to contain. The impact on global growth and the disruption to global supply chains is likely to be more pronounced and last longer than initially thought. Consequently, we have reviewed our portfolios for positions in which our longer-term conviction has been deteriorating with a view to allowing cash levels to increase modestly. We have not lifted cash materially, or meaningfully changed the shape of portfolios.
“Why have we not lifted cash materially given the increasing risk? Forecast risk is high. We don’t know the true mortality rate (the infection rate might be higher than reported and the mortality rate consequently lower). We don’t know whether COVID-19 will exhibit seasonality. We don’t know how governments globally will respond in relation to the imposition of quarantines. We don’t know the duration of the crisis. We don’t know the level of stimulus to be applied. The risk profile of our portfolios is relatively balanced. If we lift cash aggressively, successfully timing any re-entry is typically difficult.
“We will continue to monitor developments and update our thinking regarding the impact on growth, asset markets and portfolio positioning accordingly.”
Alex Tedder, Head and CIO of Global and US Equities:
“Valuation multiples have adjusted rapidly to changing perceptions of earnings risk, with stocks in industries such as technology hardware, travel and autos seeing falls of 15 to 20%. In a number of more benign scenarios this de-rating could be unwarranted, but with a number of unknowns regarding the likely effect on economic activity and corporate profitability, it is simply too early to know.
“On balance, for our global equity strategies, we remain somewhat hopeful that the impact on economic activity will be short-lived and the virus will serve to push out profits by a couple of quarters, rather than de-railing it entirely.
“At best, earnings for the first quarter will be ‘messy’ and at worst extremely ugly, providing a source of ongoing volatility as expectations adjust. From a longer term perspective, any impact of the virus is unlikely to result in a material or permanent impairment of the intrinsic value or long-term growth trajectory of the companies we look at.
“At current levels, we are more inclined to see this as an opportunity to add to positions selectively in some of the more heavily sold-off sectors and stocks, particularly those linked to travel and trade.”
Toby Hudson, Head of Asia ex Japan Equities:
“Our base case today is that despite the tragic loss of life, this will not represent a structural change in the growth outlook for the Chinese nor regional economies, but more of a short, sharp cyclical slowdown that lasts a few months.
“The economic impact is being felt most immediately in sectors linked to tourism, travel, offline entertainment and discretionary retailing, both in and outside China. More generally, the heightened uncertainty is likely to negatively impact consumer and business confidence, and, in turn, spending and investment decisions.
“Given the rapidly changing expectations for the spread of the virus, it is impossible to model the hit to near term economic growth and corporate earnings, but clearly the impact will be very material in the first half of the year for many sectors. If, as with other recent outbreaks, the spread of the virus is contained within the next few months and confidence gradually returns, economic activity should then rebound fairly quickly in the second half of the year, helped by the release of some pent-up demand and the boost from fiscal and monetary stimulus in most economies.
“Earnings forecasts for 2020 will need to be adjusted downwards materially, but critically this should have far less carry-through impact into next year and beyond. As such, the impact on fundamental fair values for the stocks we own should be modest and they are financially strong enough to ride out the near term weakness.
“In the near-term markets are likely to continue to trade based on the daily virus data. Aggregate valuations have pulled back closer to longer term averages; however, markets may well over-shoot on the downside given the limited visibility around the outlook, and a degree of ‘profit taking’ after earlier gains, is understandable. This may throw up interesting opportunities to add to our preferred names in the region.
“Looking beyond the current crisis, we remain focused on areas exposed to the secular growth themes in the region.”
Johanna Kyrklund, Group CIO and Global Head of Multi-asset Investments:
“Efforts to contain the coronavirus (COVID-19) will short-circuit the nascent recovery we were seeing in the data and so we continue to avoid cyclical areas of the equity market and commodities
“The response of central banks (such as the Federal Reserve’s rate cut) should help to stabilise sentiment. Importantly, we don’t believe that lower interest rates will re-ignite the economic recovery, but they do have an important effect on valuations and support a continuation of liquidity-fuelled equity returns.
“However, this is not a time for blithe risk-taking; we need to see evidence of a peak in infection rates or more information on the economic damage in the form of corporate earnings announcements or economic data before we can wade back into risk assets and so for now we remain at neutral.
“Our government bond positions are now very expensive following the decline in yields. We have lightened up on our rates exposure but still believe that bonds are a “seat belt” on our portfolios in case economic disruption caused by attempts to contain the coronavirus tip us into a global recession, so we still have a small long duration position in our multi-asset portfolios. We continue to favour the Japanese yen as a safe haven in currency.
“All in all, we have lower risk levels than usual. Ultimately, our expectation is that the impact of the coronavirus will be significant but transitory. Our bias is to look for opportunities to generate return, but we also need to be humble about our lack of knowledge on the future development of the coronavirus.”
Sue Noffke, Head of UK Equities:
“The events of the past two weeks are certainly very concerning for all the individuals and businesses being badly affected by coronavirus.
“However, from the perspective of stock markets, the outbreak further underlines the importance of taking a long-term investment approach and resisting knee-jerk reactions.
“Just a couple of months ago, geopolitical tensions between Iran and the US were of significant concern, as were the Australian bushfires. Brexit remains a source of uncertainty, as do the US elections, which are also coming up later this year.
“Amid all of this our focus is to remain anchored to our investment process. We will continue to build portfolios centred on stock specific ideas and mis-priced opportunities, as opposed to guessing what’s going to happen at a macroeconomic level.
“This process includes identifying potentially vulnerable companies and focussing on those which are better able to weather any economic storms.”
Martin Skanberg, Fund Manager:
“Clearly, the quick reaction from the market has been to sell off cyclicals including financials and stocks sensitive to a weaker oil price. This includes some of the best capitalised businesses in the world today, which when coupled with low valuations makes them among the least risky for those willing to take a long-term view. Our concern is for those companies that are priced for perfection. Those debt-laden ‘bond proxies’ or over-valued growth businesses such as certain luxury and staples names where the expectation has been that their earnings can never go down. High valuations are a risk because a small decline in earnings expectations tends to be multiplied in to large hole in shareholder capital.
“Markets have fallen by almost 10% since posting record highs in mid-February and whilst a reasonable amount of risk has now been factored in, we remain cautious in the near term and expect to see numerous profits shortfalls reported in April/May. But when the market sells off so aggressively, there can often be indiscriminate and irrational selling. This provides a buying opportunity in areas where we have confidence in a company’s earnings, such as our holdings in the defence sector.
“This 10% correction should be viewed against a very strong year for equity markets in 2019 when European equities posted gains of 25%.”
Nick Kirrage, Co-Head Global Value Team:
“While the outbreak of coronavirus is very concerning for the human race, it should not impact how investors think about stocks. Many of the businesses that we own are likely to be affected in one way or another; production shutdowns are likely to impact companies’ profitability in the near-term, but these are unlikely to change our normalised assumptions. We invest in businesses with sufficient balance sheet strength to weather such unexpected shocks. The long-term outlook for our portfolio of companies is not impacted by coronavirus.”
Quantitative Equity Products (QEP)
Justin Abercrombie, Head of Quantitative Equity Products:
“The excessive market optimism that we have observed over the past few years meant that equities were vulnerable to a large correction, which has been justified by the outbreak of the coronavirus.
“The direct impact on a number of exposed areas has been quite pronounced, most notably the selloff in commodity-related stocks (particularly oil), industrials (transport), entertainment, luxury goods, semis and autos. There has also been a broader impact via weaker sentiment towards global growth, resulting in defensive stocks performing well, particularly those with the perception of being bond-proxies, such as utilities and real estate.
“However, despite many of the most crowded and popular growth stocks being very exposed to China, either directly or via their supply chains, they have, for the most part, continued to perform quite strongly over the year-to-late February, some by a considerable margin. In short, the coronavirus has not yet led to a more broad-based rotation in market leadership.
“From an attribution perspective, the direct impact on our strategies is modestly negative. We are only marginally overweight the oil majors in our more value-focused strategies and the headwinds from our holdings in areas such as auto components and transport are not pronounced. More detrimental has been the indirect impact upon our low exposure to the bond-proxy areas and the continued outperformance of the large-cap “growth” stocks.
“We increased the focus on financial strength in our approach to stock selection during 2019, which has assisted, and would also note that, despite the strong gains posted year to date by the popular stocks, market breadth has been generally higher on the down-days, which has also been supportive.
“Looking ahead, we are stress testing our portfolios in order to take into account a number of scenarios for earnings downgrades for the most exposed stocks, which may lead to some adjustments to positioning. However we are also being cautious about making material changes so that we do not miss a potential buying opportunity, particularly if markets over-react in the short run.”
US small and mid cap equities
Bob Kaynor, Head of US Small and Mid Cap Equities:
“It has been our view that US equity returns in 2020 would have to be driven by earnings growth as opposed to multiple expansion. Last year experienced large returns in equity markets, with no commensurate growth in earnings (i.e., returns were driven by multiple expansion) – historically, following periods like this, earnings growth is required to drive equity returns.
“We believe COVID-19 is going to impact the earnings growth prospects through the first half of 2020. While the ultimate magnitude of the impact remains uncertain, until we see clear containment (in the number of cases and geographies) market volatility will remain elevated until the risk can be appropriately priced. We expect the repricing of risk assets to have run its course by the end of the first quarter, even though the economic impact will continue to be felt through the second quarter. For the time being, we believe the step back in growth is transitory and not a fundamental challenge to the economic cycle.
“As long-term investors we take advantage of periods of volatility. Towards the end of the February we had begun repositioning the portfolio to take advantage of market dislocation to upgrade the quality of the portfolio and add opportunistically to mispriced growth stocks that have come down with the recent downturn. It had been difficult for us to add to growth earlier in the year due to extreme valuations.
“At the time of writing, the stock market has just had its worst week since the 2008 financial crisis. COVID-19 is an untimely shock, but hitting at time when the US economy has been strong. While it is easy for investors to panic in this period of uncertainty (especially as it is not yet clear if the virus is transitory or fundamentally changing the cycle), times like these often create the greatest buying and return opportunities.”
Philippe Lespinard, Co-Head of Fixed Income:
“Regarding government bonds, our overweight duration (sensitivity to interest rates) position has benefitted as sovereign bonds have rallied on a global scale following the move to safe-haven assets. Our overweight position in the US, which we have increased, captured these moves and performed particularly well.
“From a credit perspective, so far we have seen the market asking for higher premiums to compensate for the unknown risks associated with the virus. Credit spreads have widened across the market, but particularly so in parts of the market where very little risk was already being priced in, such as in the high yield market. While the markets continue to appraise the impact from the virus on the global economy, we remain comfortable with the defensive position of our portfolios.
“Our understanding of individual business models of companies allows us to take a forward-looking view of which issuers and issuer supply chains are the most vulnerable. This understanding, combined with uncertainty-driven volatility will create more opportunities going forward once the immediate threat of the virus starts to fade.
“Looking ahead, while the situation remains extremely fluid, we are confident that the systemic effect of the virus will eventually fade, and the periodic volatility that follows news headlines will create some further opportunities to identify issuers that have experienced relatively limited impact from the virus on their cash-flows.
“Our views remain in line with our fundamental macroeconomic strategic outlook, many of our positions reflect our theme of lagged central bank stimulus driving global growth in 2020. However, we stand ready to take advantage of valuation opportunities presented by the current market environment and protect against potential risks with cost effective offsetting positions.”
Asian fixed income
Roy Diao, Head of Asian Fixed Income:
“The industries that are most vulnerable to the COVID-19 shock are manufacturing, gaming, tourism and consumption/travel-related industries (retail, airlines etc.) as they have borne the brunt of the demand shock as travel-related activity has dramatically reduced. However, these sectors have a relatively low weight in the Asian credit markets, which explains the relative resiliency of the asset class.
“While we expect to see near-term pressure on certain sectors, overall credit fundamentals of Asian credit still look largely intact as the universe has built up some immunity in recent years with net debt/EBITDA trending down and liquidity remaining adequate.
“Demand for Asian credit should continue to be supportive, particularly from regional investors’ perspective given healthy inflows to emerging market and Asia-focused bond funds, growing wealth of private banks and a strong appetite for USD assets among onshore China investors. Net supply also remains limited outside China.
“It requires careful industry allocation, credit selection and scaling of risk exposure to navigate the market dislocations. Across our Asian credit strategies we are tilted towards higher credit quality by rotating from BBB-rated to A-rated companies, and from quasi sovereigns to sovereigns in certain countries like Indonesia. We have also exited or reduced exposure to issuers that were expected to face more difficult operating environment, such as travel and retail.
“If the past is any guide, business activities and economic growth should normalise over time and COVID-19 may be remembered not so much with dread when we look back years from now. Still, as it’s too soon to tell with confidence the ultimate impact of the coronavirus, we would remain vigilant in portfolio positioning and caution against making bets on a rapid and sharp rebound.”
US multi-sector fixed income
Andy Chorlton, Head of US Multi-Sector Fixed Income:
“We entered the year with the lowest risk profile since the financial crisis across our portfolios. This was because we did not believe we were being compensated for risk in a number of sectors, given our concerns around deteriorating fundamentals and expensive valuations. Our concern was the lack of cushion, either in terms of financial flexibility at issuers or from an investor perspective in terms of price, to weather any kind of deviation from this liquidity-fuelled cycle.
“Our expectation was of a more traditional end to the cycle than what we are currently experiencing, but still means that our portfolios are well-positioned given the recent volatility. In general, we have been looking for alternatives to corporate credit, which we consider the most stressed sector. This has led to investments in commercial mortgage backed securities (CMBS) and taxable municipal bonds as these sectors both have better fundamentals relative to corporate bonds. They allow us to diversify our corporate risk while maintaining an attractive yield with good liquidity in the portfolios.”
Michelle Russell-Dowe, Head of Securitised Credit:
“Securitised credit markets have been relatively immune to the recent market volatility, as we would expect, and remain fully functioning. We are, however, seeing investors looking to sell the most liquid securities or sell out of winning positions.
“As such, we are seeing some erosion of the valuation differential between different quality securities, with the more liquid, higher quality paper moving toward more attractive levels. This has started to present opportunities for us to add to the “best-in-class”, larger, more liquid sectors, which have been our preferred areas to invest in for some time. As we see selling move to other more credit-sensitive securities, we should see potential for re-pricing that could create value-oriented opportunities.
“We have seen limited declines in price, except for in the lower parts of the capital structure, or in the more obviously vulnerable sectors such as aircraft asset-backed securities and collateralized loan obligations.
“The domestic-oriented housing, real estate and consumer credit sectors look well supported with spreads marginally wider. Housing credit is set to benefit from supportive sector-specific factors, with mortgage rates at new lows, and looks an attractive place to add.”
Nils Rode, Chief Investment Officer, Schroder Adveq:
“For existing private equity investments, the impact varies mainly by region and industry, the specific business model of a company and its financing situation. While several private equity portfolio companies are likely be affected negatively, at least temporarily - and some could be affected more severely - many investments are well positioned to go through this situation without any permanent impairment. A few companies might even be able to benefit from the situation (for example, companies working on potential treatments).
“For new private equity investments, the outlook additionally depends on the type of investment:
- For primary investments, the economic impact of the novel coronavirus can lead to more favourable entry valuations over time. Furthermore, primary fund investments benefit from time diversification during the typical investment period of 2-4 years.
- For secondary investments, economic and financial market turbulences can create buying opportunities. So, in case of extended turbulences, the current coronavirus situation could result in such buying opportunities.
- As new direct/co-investments could potentially experience some type of short-term impact, we expect investors and fund managers to slow down their investment pace for direct/co-investments. Direct/co-investments can potentially benefit from more favourable entry valuations, but high selectivity will be paramount.
“Private equity is generally well positioned for surprising shocks such as the one created by the coronavirus. Private equity funds are well capitalised with locked-in capital that can either be deployed for new investments when opportunities arise, or that can be used to support existing portfolio companies if and when necessary.
“Additionally, the long investment time horizon of private equity funds provides the industry with a high level of flexibility with regard to exit timing, which means that private equity managers and their investors can keep a calm mind even in turbulent times.”
More Schroders insights on coronavirus are available below:
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