Quarterly Portfolio Update – Q2 2020

And breathe. That was without doubt one of the most volatile and precarious starts to a year for markets that many of us have witnessed in our lifetimes. And clearly for good reason.

As you will know, whether from watching the news or if you managed to catch a glimpse of our blog posts, which are still available to read on our website, the world has effectively ground to a halt due to the outbreak of COVID-19.

At the time of our first blog post about Coronavirus (28 February 2020), the virus had reached 55 countries; by the time we posted our second blog (13 March) this had more than doubled to 125 countries. As we write this today, 234 countries and territories have confirmed at least 1 case of COVID-19, with just under 2.2 million individuals testing positive for the virus. There are only a handful of countries that claim to have had no confirmed cases; these are either tiny islands or those whose information is likely spurious, unsurprisingly North Korea is one of said countries to have no confirmed cases.

There are an array of words and sayings that weren’t part of our vocabulary now, but are used more and more frequently everyday .. here goes:

Flattening the curve is a key focus for Governments; which is whereby the number of new cases confirmed aren’t increasing at an exponential rate (think of this as an increase in acceleration). This flattening will mean that countries should eventually reach a peak in the number of new cases each day, before eventually beginning to decline.

Many countries have initiated several measures to limit the spread, including enforcing a lockdown by people staying indoors (enforcing self-isolation), and for everyone to be social distancing … I think we have all become experts in gauging 2 metres. The more vulnerable have had to shield themselves.

Scientists tirelessly research a vaccine and cure whilst key workers continue to keep our country going. Whilst a vaccine is not yet ready, the effectiveness of herd immunity has often been mentioned as a possible way to control the virus. This is whereby the population build up an immunity to the virus such that it is unable to spread effectively (of course herd immunity would be significantly easier if there were a vaccine).

The markets reacted extremely negatively to the news, at a lightning pace. It took just 14 trading days for UK equities to fall by 30% in value. Over in the US, it took their equity markets 22 days to fall by the same magnitude. To put this in perspective, during the Global Financial Crisis (GFC) in 2007-08, it took ~250 trading days for markets to fall by the same amount. This was at a time when where the stability of the entire financial and banking sector was called into question and hung in the balance.

And of course the economic implications are plain for all to see. Governments around the world have had to step in to financially support businesses, the working population, charities and other entities (fiscal policy). Central banks have also stepped in to support the financial markets through a combination of cutting interest rates and further quantitative easing (monetary policy).

It is of course difficult to say at this point the magnitude of the effect this will have on global economic growth. China have released their GDP data for Q1 2020 which shows a fall of 6.8%, the first quarterly contraction in a record of gains going back to at least 1992 and their worst annual growth (effectively flat for the 12 months to end of March 2020) since the late 60’s. Expect a similar trend as other countries report their economic data.

The International Monetary Fund (IMF) having estimated global growth of 3.3% for 2020, are now forecasting a contraction of 3.0% for the year, which would make it the worst year since the great depression. As a comparator, global GDP fell by 0.1% during the Global Financial Crisis.

Naturally, it is easy to use 2007-08 as a yardstick from which to judge the current situation, it is the most recent economic slowdown prior to this, although it feels like a lifetime ago! However, as is often said, it IS different this time. In the aftermath of the Global Financial Crisis, employment levels, as well as several industries and many businesses, were taken out at the knees, for reference it took nearly 8 years for UK unemployment figures to reach their pre GFC levels.

Prior to the lockdown, the global economy, for all intents and purposes, was in a fairly good position. Some may argue that we were at the late stage of an economic cycle; but signs pointed to continued economic growth. So when this lockdown does end, one would like to think that the economy is positioned to rebound sharply.

But of course, this all hangs significantly on the question, when? When will a vaccine and cure be found and when can we end the lockdown and social distancing?

To elaborate on the previous IMF estimates, the institute forecasts global GDP to rebound sharply in 2021 to 5.8%; although this is on the basis that the pandemic peaks in the second quarter of this year. According to the IMF “If the pandemic continues into 2021, [global economic growth] may fall next year by an additional 8% compared to our baseline scenario”.

As previously mentioned, markets reacted ferociously as the threat the virus presented came into sharper focus. The VIX (Volatility Index), which aims to measure the volatility of the S&P 500, hit an all-time high on March 16 of 82.69. A figure above 20 is considered high whilst a figure below 12 is considered low. But it was the fact that nearly every asset class was sold off during the second week of March that was perhaps most surprising. Sure, in a time like this, a sell-off in equity markets is a given. But the sell off during this time, like the Coronavirus, did not discriminate. Typical safe havens like government bonds and gold took a hit around this time, as investors dashed to cash, or perhaps sold off these assets to raise liquidity, rather than sell the assets that had fallen far worse.

This leads us on to one of our key mantras when it comes to investments and managing money, it is all about time in the markets, not timing the markets. During the first two weeks of March, it could have been easy for investors to panic, cut their losses and sell out given all of the uncertainty.

But, as we know, this would be the wrong approach. It is easy for emotional biases to take over and for investors become irrational. This is in part why a robust Risk Profiling Process and a suitably mapped risk rated investment strategy is so important. Of course the downturn that we saw in markets and therefore in our MPM portfolios wasn’t pleasant; but the drawdowns we saw across our portfolios were in line with our pre-crisis estimates for each of the respective portfolios.

The drawdowns that we saw led to a large majority of investors in Discretionary Fund Managers receiving a notification that their portfolio had fallen by 10% or more since the start of the year. The effectiveness and usefulness of this relatively new regulation have been called into question by many in the industry, as this is another potential trigger for investors to react irrationally. The regulator has subsequently paused the rule until October.

To highlight the point about not trying to time markets, since our MPM portfolios reached their lowest point over the year to date (19 March 2020), our most adventurous portfolio, MPM100, has regained 40% of losses, MPM060 has recovered 50% of losses and MPM030 has recovered over 70% of losses (as at 17 April 2020).

The current market turmoil has also largely been impacted by the ongoing saga in the oil market, which was in part affected by the pandemic. At the start of March, the Organization of Petroleum Exporting Countries (OPEC) presented an ultimatum to Russia to cut production by 1.5% of world supply.

Russia, which foresaw continuing cuts as American shale oil production increased, rejected the demand. This came on the back of an agreement in December 2019, in which OPEC and Russia had already agreed to one of the deepest output cuts.

Saudi Arabia reacted to Russia’s refusal by increasing the output and offering a discount of $6 – $8 a barrel to customers in Asia, the US, and Europe. On the back of the announcement, oil prices fell by more than 30% in one day.

Combine this continued supply and discount with a significant fall in demand, not many people are driving or flying right now, it is clear to see why oil price volatility is so high. In fact, at time of writing, the WTI Oil Future for delivery in May 2020 turned negative, the first time this has ever happened, reaching as low as -$40 per barrel. This means you were being paid $40 to take a barrel of oil off producer’s hands! This perhaps highlights the issue with storage and how full reserves are at present.

So where do we go from here? Clearly we are not out of the woods yet; as the IMF stated, a lot depends on how long it takes for current circumstances to change. We could well see markets retest their previous lows, but then we might not. For us, it is not about trying to second guess and to time markets. It is ensuring that our portfolios remain well diversified and that the appropriate risk is being taken. We have towards the end of last quarter been adding positions to areas that we feel offered good value, you can read more about the changes we made over the quarter in the Portfolio Update section, but we continue to retain an element of cautiousness.


with Peter Montague

Those with a remaining shred of faith in the world’s international or supranational organizations might be interested in the International Monetary Fund’s (IMF) estimates of the economic impact from the near-universal ‘lockdown’ response to COVID-19. For context, note that the global economy expanded at an inflation-adjusted 2.9% during last year. That comprised growth averaging 1.7% across the advanced economies and 3.7% across the developing and emerging market economies.

For the current year, the tea leaves at the bottom of the IMF cup project a bitter decline totaling 3.0% at the global level and incorporating falls of 6.1% in the advanced economies and 1.0% across the rest.

On a sweeter note, and contingent on the assumption that ‘the pandemic fades in the H2 2020 and containment efforts can be gradually unwound’ global growth will stir toward a 5.8% gain next year when gains average 4.5% for the advanced economy group and 6.6% for the developing and emerging economies. Here’s how the estimates fall for each of the G7 nations:

USA +2.3%, -5.9%, +4.7%
CAN +1.6%, -6.2%, +4.2%
GBR +1.4%, -6.5%, +4.0%
FRA +1.3%, -7.2%, +4.5%
GER +0.6%, -7.0%, +5.2%
ITA +0.3%, -9.1%, +4.8%
JAP +0.7%, -5.2%, +3.0%

And the same for the BRICS:

BRA +1.1%, -5.3%, +2.9%
RUS +1.3%, -5.5%, +3.5%
IND +4.2%, +1.9%, +7.4%
CHI +6.1%, +1.2%, +9.2%
SAF +0.2%, -5.8%, +4.0%

The China and India figures in the middle, representing the estimates for growth in 2020, are not typos by the way – they really are positive. Bear in mind that these are for the full year, reflecting big but temporary declines in the early part of the year (Q1 in China and Q2 elsewhere).

The 2020 numbers are horrible. They compare with the output declines experienced during 2008-09 when the US economy contracted around 4.0% and the British and German economies contracted by close to 6.0% and 7.0%, respectively. We don’t know if those forecasts are going to be remotely accurate, but we are with the IMF in spirit because we too expect a big decline this year and a big gain next.

Mind you, in the interim, you’re going to read about some much bigger numbers than those. That’s because headlines will focus on the data as it arrives and not on its likely evolution over the course of the full calendar year.


with Steve Williams

The Office For Budget Responsibility (OBR) has just hit the headlines having projected a whopping decline in UK gross domestic product in the region of 35% during Q2.

Less well-reported is that the OBR’s estimations couldn’t possibly be described as a ‘central forecast’ along the lines of those issued by the IMF. The OBR’s analysis forms what they term to be an ‘illustrative scenario’ and is intended to provide a basis on which policy decisions can be judged. The reference scenario cited is predicated on a full 90-day lockdown, (not a 30-day lockdown, not a 60-day lockdown, a full 90-day lockdown) followed by a gradual easing over the following 90-day period.

In those circumstances, the relevant calendar year decline amounts to something approaching 12.8% because the 35% freefall in Q2 is arrested and output ‘bounces back quickly’ thereafter – with increases in the order, in fact, of 25% during Q3 and 20% in Q4.

Mind you, if you think a full 3-month lockdown is likely, the OBR’s ‘illustrative scenario’ isn’t a bad proxy for your ‘central scenario’.

Meanwhile we think a 3-month lockdown is unlikely. We’re not alone in thinking that, as is evident in the IMF’s ‘central forecast’ for a 6.5% decline.

Other forecasts we’ve seen, and which might reasonably be described ‘central forecasts’, range between -10.2% (SocGen) and -1.9% (Hetronomics) with a median of –6.4%, almost exactly in line with that from the IMF.

The numbers that really count, of course, are those that will be captured in measures of joblessness. The consensus – insofar as a consensus exists – sees unemployment move from 3.9% at the end of last year to 6.5% by the end of this year. The OBR’s ‘illustrative scenario’ puts unemployment at a heart-breaking 7.3%.

It is sobering to think how high those numbers might have been (and might yet still be) had the Bank of England not acted swiftly to maintain a proper functioning financial system and had those moves not been allied by HM Treasury’s efforts compensate employers for the forced closures. That’s what does for optimism these days.


The hammer and the dance

Stock prices have moved in optimistic fashion of late, haven’t they. The MSCI World index peaked at 2,431 on 19 February before falling 34 percent to 1,602 on 23 March. A decline of 34 percent is big but it’s nothing like the 50 percent decline that came about during the 2007-08 Global Financial Crisis.

No matter, the MSCI World index now stands at 2,017, some 26 percent higher than the 23 March low. That fact alone is enough to make some investors nervous.

Scott Minerd, Chief Investment Officer at New York-based Guggenheim Investments, is convinced that stocks are ‘propped up by liquidity’. With the S&P 500 index up at 2,850 today, he is warning of a likely retreat to much lower levels. He is quoted by Bloomberg as saying, ‘it could be 1,500, 1,600, 1,200’.

Quite what ‘propped up by liquidity’ means, and why any of the numbers he picks might offer more realistic valuation levels is left out of the report. We do, though, get an insight into the reasons for his pessimism. He is said to be forecasting ‘rolling shutdowns for the next two years, preventing a full-scale return to work’.

As it happens, Scott Minerd and us would agree on quite a few things. COVID-19 isn’t going away any time soon and it seems quite reasonable to assume that it could have an impact on our societies for two years or more.

We’re going to see a great many lost lives and a great many lost livelihoods. And therein lies the puzzle that the stock markets are trying to unpick.

On one side of the equation are the number of COVID-19 deaths and injuries and on the other side are the deaths and injuries associated with sustained and/or rolling economic lockdowns. The damage wrought by COVID-19 is in sharp focus, but severe societal restrictions, and plummeting economic activity, are not without their consequence. The question is not one of ‘health versus wealth’, it is of health versus health.

The more we know about COVID-19, the more we increase our hospital capacity, the more we learn to contain the spread, the less damage it will do. At the same time, the longer the lockdowns persist, the more damage they will do. There is a trade-off here. In our judgment, severe restrictions on economic activity will not last for as long as two years, COVID-19 or no COVID-19.

Our understanding of the virus and the necessary policy response was helped along in leaps and bounds when we came across Tomas Pueyo’s articles published on medium.com. That’s where we picked up ‘The Hammer and The Dance’ metaphor and from that moment, our research has been better focussed and we quickly developed a more useful framework for analysis.

Incidentally, be careful when you google ‘The Hammer and The Dance’. You’ll almost certainly hit upon the right article, but the temptation to click on an MC Hammer dance tutorial might manifest in a little lost time and an amazon order for a pair of ‘hammer pants’. Anyway…

We realise now that, prior to reading Tomas Pueyo’s musings, we had underestimated the immediate threat that COVID-19 posed. The reality was far worse than we imagined and doing nothing was not an option for policymakers. Given what we know, the lockdowns are a rational response.

The lockdown phase is represented by The Hammer. The Hammer is a drastic tool with two objectives:
1) buy time to increase capacity across the healthcare system; and
2) control the outbreak.

The outbreak is controlled when the spread rate is characterized by an ‘R0’ (‘R-nought’ or just R for short) of less than 1, meaning that, on average, those infected pass the infection on to less than one other person. We don’t know what the true R number is, or was, but in some parts of Europe it is estimated that it was as high as 3 or 4 in the early phase of the pandemic. This is why it accelerated through many countries in a matter of weeks.

In the last few days, at just over 3 weeks into the lockdown, Sir Patrick Vallance, the British Government’s Chief Scientific Officer, has speculated that R has now fallen to less than 1, perhaps to 0.6.

And so, it appears that The Hammer works. Though we don’t actually know if R would have come down all the same even with less stringent measures. Remember though, that The Hammer will not eliminate the threat from CoVID-19. The threat remains and there will still be daily incidents of new cases and, sadly, more deaths.

That is why The Dance is so important. And it is a dance that will go on long into the night, until a vaccine is found.

The main objective of The Dance is to maintain R at or below 1. With an effective testing regime, life can begin to look a little more ‘normal’. Still not actually normal, mind, but the more effective the testing regime, the better the contact tracing effort, the further into normality life can extend.

Social distancing in its milder form, including wearing masks, bans on large gatherings, travel restrictions, and ramped up hygiene will all still be necessary. But more businesses will be allowed to open.

Of course, there will be times when, and places where, R creeps above 1, necessitating a stricter policy response but those measures will be temporary and can be applied at a local, rather than national, level.

Just as there is evidence to support The Hammer phase as an effective policy tool. There is increasing evidence to support The Dance phase too. It is working in China, South Korea and Taiwan. In the next few weeks, before The Dance begins in the UK, we will have further evidence from Europe, particularly in Germany and some parts of Italy. We’ll also have further data from Sweden where The Hammer phase was, almost uniquely, skipped entirely.

Each day we learn something new about the virus, how to treat it and how to contain it.


Bank of England base rate

After the flip flopping of interest rates changes agreed by the Bank of England across 2016 to 2018, due to the results of the EU referendum, 2019 saw interest rates held level throughout the year. The Monetary Policy Committee agreed to retain the headline rate at 0.75% interest rates, with the caveat of potentially reducing interest rates, should the withdrawal from the European Union have an adverse affect on the UK economy.

Brexit had very little impact on the decision for the Bank of England to make two cuts during March, firstly by 25 basis points to 0.5%, and then a further 40 basis points, to leave interest rates at just 0.1%, in addition to the further £200 billion of Quantitative Easing. The Bank Of England has stressed that it is unlikely to cut interest rates further, as they do not intend to have negative interest rates. On the flip side, it seems unlikely that an interest rate rise will happen any point prior to the UK economy showing signs of recovering from the effects of the lockdown.


Pound Sterling

After a strong rally in Sterling at the end of last year, the first two months of the year were fairly flat for the Great British Pound. When COVID-19 reached the UK and threatened to, and eventually did, shut down London, the pound wobbled and saw some significant falls, naturally because of the concerns regarding of the impact on the UK economy, but also on the impact of the ongoing trade negotiations with the European Union. At the end of Feb, £1 bought you $1.29. During the middle of March, the sterling dropped as low as $1.15, before ending the month at $1.25 per £1. However, sterling wasn’t the weakest currency of the first quarter of 2020, that award belongs to the Australian Dollar, which fell by 12% in spot returns (compared to GBP losing 6%). The Aussie Dollar was likely hit by a combination of interest rate cuts, trade tensions, bushfires and a slow in Iron Ore and Coal exports.


UK Property Market

The Nationwide House Price Index (HPI) revealed that annual UK house price growth for the year to March 2020 came in at 3%, up from 2.3% in the previous month. This is the largest annual growth since the 12 months to January 2018.

Robert Gardner, Nationwide’s Chief Economist notes:

“It is important to note that, while we use a full month’s worth of data to generate the index, the cut-off point is slightly before the end of the month. This means that developments following the UK government’s lockdown will not be reflected in these figures.

In the opening months of 2020, before the pandemic struck the UK, the housing market had been steadily gathering momentum. Activity levels and price growth were edging up thanks to continued robust labour market conditions, low borrowing costs and a more stable political backdrop following the general election.

But housing market activity is now grinding to a halt as a result of the measures implemented to control the spread of the virus, and where the government has recommended not entering into housing transactions during this period.

Indeed, a lack of transactions will make gauging house price trends difficult in the coming months.

The medium-term outlook for the housing market is also highly uncertain, where much will depend on the performance of the wider economy.”

The most recent report for the commercial sector is for Q4 2019. Given how much the market has changed in the three months since then, it feels almost redundant referencing this most recent report.

It is inevitable that the commercial property market will take a hit from the Lockdown, much like the residential market. But whether that be a quick correction or a more slow and painful time of things, remains to be seen. One point that may have come out from the pandemic and the lockdown is the reduction in importance on being office based all the time. Many businesses and employees have had to adapt to working from home and, in the main, seemed to have coped pretty well. If less of a significance is placed on commuting and office working, this could naturally have an impact on commercial property prices (in the office sector anyway).

During the quarter, many of the direct property funds gated, meaning investors are unable to withdraw their money. The new rules introduced by the FCA in 2019 state “A requirement that NURSs (Non UCITS Retail Schemes, which many direct property funds are) investing in inherently illiquid assets must suspend dealing where the independent valuer determines there is material uncertainty regarding the value of more than 20% of the fund’s assets. Following feedback the FCA will, however, allow fund managers to continue to deal where they have agreed with the fund’s depositary that this is in the investors’ best interests.” Given the market uncertainty, many managers are unable to value the properties in the fund and therefore have gated these investment vehicles until further notice.


with Scott Mordrick, CFA

All of our portfolios are ahead of their benchmarks over 1 year (to end of March 2020), the first quarter provided some variance in returns, the more cautious portfolios outperformed their benchmarks, and portfolios MPM050-090 slightly under-performing their respective benchmarks. Understandably it was a very difficult quarter for all portfolios, with all of them falling in value.

Positive Contributors
The key contributors to performance over the quarter were:

  1. Our Gilt allocation. We increased Gilt duration at the start of March to offer further hedges against stock market falls.
  2. Our Alternative allocation. Physical Gold increased in value, as did two of our three absolute return strategies.

Negative Contributors
There negative contributors to performance over the quarter were:

  1. Our exposure to Investment Trusts. There was an indiscriminate sell off of all asset classes, particularly those that are more liquid, which Investment trusts tend to be, compared to the possible underlying assets themselves, such as Property, unlisted equity or High Yield Bonds.
  2. Value and Mid/Small Cap equity managers. Although we have a slight bias to large cap growth managers over more value or mid/small cap orientated managers, our exposure to these styles had a negative impact.

To some extent, this was a bit of a surprise, growth stocks were already trading at significant multiples and it may have been obvious that these would be hit harder during an effective economic standstill.

Portfolio Changes

  1. At the start of March we restructured the Overseas Bond and High Yield Bond sectors. We reduced the allocation to Overseas Bonds from Favour to Like by removing the two M&G global bond funds and replaced them with the iShares Government Bond tracker and Stratton Street Next Generation fund. We reclassified the NB Global Floating Rate note from Overseas Bond to High Yield Bond, and removed the Royal London Global Short Duration High Yield Bond fund. We increased Corporate Bonds from Neutral to Like by adding the Merian Financial CoCo fund.
  2. A week later, we increased our Gilt duration by increasing the allocation to Long Dated Gilts from Less Keen to Neutral, and reducing the allocation to Short Dated Gilts from Neutral to Less Keen.
  3. At the end of March, we further reduced the allocation to Short Dated Gilts from Less Keen to Disfavour and increased the allocation to Corporate Bonds from Like to Favour by adding the L&G Managed Monthly Income Trust.