Quarterly Portfolio Update – Q3 2020


with Scott Mordrick, CFA

My first foray into this industry was in the middle of 2008, just months before the collapse of Lehman Brothers and the subsequent equity market falls – in which we saw some of the biggest one day losses in UK equities on record (only surpassed by the losses in the aftermath of Black Monday 1987 and this year). There is no doubt that it was a baptism of fire! But, without meaning to continually dredge up the same old adage, ‘this time it was different’.

And there is a reason why we say this. Sure in 2008, market volatility was extremely high; the VIX, widely seen as a measure for market volatility, went to over 80 during 2008 (a similar level to where it reached at the peak this year) – its long term average is around 20. However, you only need look at the way the bond markets behaved to see how different it was.

The problem this time around was that markets stopped functioning. It is understandable to assume and see significant market falls in the face of an unknown crisis; however even in market falls we would expect to see a market functioning with buyers and sellers, a bid (sale) price and an offer (purchase) price and general liquidity. This effectively dried up in nearly every bond market in March; hence why we saw the Bank of England step in with a promise to inject £200 billion of liquidity into the bond market, with at least half being used to buy Gilts.

This brings the total amount of Quantitative Easing (remember that keyword! Seems almost forgotten given everything that has been going on) done by the Bank of England to £645 Billion.

Meanwhile, across the pond, the US Federal Reserve also announced further QE measures, with an additional $700 Billion of bond purchases. This brings the Fed’s total asset purchase to a total of, wait for it, $7 trillion. The Fed’s announcement did signal a change in tact however, as this is the first time they are buying investment grade Corporate Bonds and lending to businesses. The Fed has also intimated that they may step in to the High Yield Bond market if it deems it necessary.

The European Central Bank also announced a €750 Billion asset purchase, which will be carried out until the end of this year, as part of its Pandemic Emergency Purchase Programme (PEPP).

Quantitative Easing wasn’t the only Monetary Policy “arrow” used by Central Banks – Interest Rates were cut significantly. As we touched on in our Q2 2020 Portfolio Update, the Bank of England cut interest rates from 0.75% to 0.1%, the Federal Reserve slashed rates from 1.75% to 0.25%, Norway cut their rates from 1.5% to 0%. Of course, some central banks were limited in their ability to cut interest rates any further; the ECB have rates set at 0%, and have done for over four years.

All of this intervention from Central Banks brought back confidence, liquidity and ultimately much needed functionality to the bond markets.

And it wasn’t just bond markets that rallied during the second quarter – equity markets had an extremely strong second quarter, the best performance coming from Asian and Emerging Market equities (those typically seen as higher risk).

Disappointingly, it is UK equities that are lagging most other equity indices. For the year to the end of June, UK equities are off ~16.5%, US equities are only down 3%, Japanese equities down 5%, European equities down close to 10% and Emerging Market equities down around 12% (in local currency terms). The ongoing uncertainty regarding Brexit (again, remember that!), the concerns that the COVID-19 pandemic has hit the UK harder than others and that it will take the UK economy longer to recover are the main causes.

What has been intriguing when reviewing equity markets has been the disparity and divergence of performance between different sectors. In times of drastic market falls, one would expect the more value orientated sectors to hold up better. But it was, to some extent, the opposite that happened. Some stocks in the Banks, Energy and Utilities sectors had a fairly torrid first half of the year; meanwhile Technology and Healthcare stocks (despite the ongoing Coronavirus pandemic) had a fantastic start to the year. To some extent these disparities stand to reason; regardless of lockdown and social distancing, tech companies have continued to thrive (Amazon haven’t exactly stopped delivering!) – in fact you may say we as consumers and users have become even more reliant on the services provided by companies like the Big Five (Microsoft, Facebook, Apple, Amazon and Google). One only needs to check out the share price performance of Zoom over the year to date (up 270%) to see, quite possibly, where the world is heading.

The sway these tech firms have over markets now is quite astounding; as it stands the aforementioned Big Five makes up c25% of the whole of the S&P 500s value (~$6 trillion – nearly as much as the Fed’s Quantitative Easing bill!).

But will we see a repeat of the .com tech bubble we saw at the turn of the century? It’s difficult to say; there are several key differences this time. Firstly, as mentioned, these companies make up a significant portion of the equity markets now, so it would perhaps need a smaller shockwave to have as great an effect. However, this time around these companies are making profits, and not insignificant amounts. The Big Five generated revenue of $900 Billion in 2019. By comparison, if they were a country, Big Tech’s earnings would make it the 18th largest country by GDP, ahead of Saudi Arabia and just behind the Netherlands.

Earnings growth also continues to outshine pretty much every other sector; the majority of Tech companies earnings growth is forecast between 40-80% per annum, whilst other industries have far more modest growth expectations between 1% and 9% per annum.

But regulation and taxes remain extremely light on these companies; a change in this could well see their profits affected and their valuations downgraded.

As headlines have been undoubtedly dominated by Coronavirus; the news has become increasingly focussed on the Black Lives Matter movement, following the killing of George Floyd by an American police officer.

There have been demonstrations, not just in the USA, but around the world, as people make their voices heard. Whilst there have been some positive progress with conversations/debates, there has also unfortunately been some protests which have turned violent; in America we have seen the most damage as stores and neighbourhoods have been ransacked and destroyed.

Last week we had Rishi Sunak, the Chancellor of the Exchequer, announce his Summer Statement, the latest in a series of announcements since he presented his Spring Budget on 11 March in response to the economic impact that Coronavirus and the lockdown has had. The focus on this statement was about “supporting, protecting & creating” jobs. You can read more about this statement in our review on our website.

With all this support provided by the Government, all eyes will be on the Autumn Budget to see how the Government will recoup back the significant amount of spending they have made; in particular on the Furlough Scheme, which allowed employers to furlough members of staff (rather than make them redundant) with the majority of their salary paid for by the Government. Somewhat pleasingly for the Government, the estimated cost of this scheme (by the OBR) has been revised down, from £84 Billion to £60 Billion.

As society returns back to some level of normality – with a relaxation on lockdown rules and the ability for the hospitality industry to resume (an albeit limited) service – so, do we hope, will markets.

The first half of the year saw an almighty drop in value, with a decent bounce back. We think it is unlikely that markets will test the lows we saw in the middle of March, but that is not to say we won’t see another 10% drop from here. These sort of drops are part and parcel of market movements. It is probably fair to say though that the market buoyancy we have seen in the last couple of months is on the assumption that we are past the worst of the Coronavirus – if we’re not, then all bets could well be off.

Regardless, this first half of the year has once again proven how important it is to maintain a diverse portfolio of assets and ensuring that investors have a level of risk in their portfolios that they are comfortable with.

Whilst it is clearly too early for self congratulating, it has been pleasing to see how well our portfolios performed, not only how they held up during the downturn in the first quarter, but how strongly they have rallied in this second quarter. It has certainly been a busier time than normal for the Investment Committee, with meetings moving from monthly to weekly, as the ever changing global economic landscape was moving at an even faster pace during the last six months. As readers will know, we do not try to time markets or be frequently trading the portfolios; however we have made several changes and rebalances throughout the start of this year which have been very beneficial to the portfolios and their subsequent performance. If you would like more information on the performance of our portfolios, please get in touch. But for now, from all of us here at Montage, stay safe and we will hopefully see you soon.


with Steve Williams

This is a time peppered with large numbers. Prime among those numbers is the count for confirmed COVID-19 infections, currently at 250 thousand here in the UK and 12 million worldwide. The really big numbers are to be found in the policy response though; that’s were you’ll find the billions and the trillions.

At the close of last year, British government debt amounted to £1,892 billion, equivalent to 85% of gross domestic product (GDP). The Office for National Statistics reports that the deficit – representing net borrowing – stood at £46.1 billion, equivalent to 2.1% of GDP for 2019. Actually, and just for context, that compares favourably with the 3.0% mark that forms the upper limit

for compliance with the European ‘Stability and Growth Pact’. But that was last year. The numbers for 2020 will change radically. Net borrowing in May 2020 alone is estimated to have been in the region of £55.2 billion. That’s a staggering £49.6 billion more than May 2019’s figure of £5.7 billion. Total tax receipts were down 28.4% (compared with the previous year) owing to a 46.0% drop in VAT receipts and a 27.2% fall in income tax revenues. Meanwhile, and perhaps not surprisingly given the scale of commitments representing the Coronavirus Job Retention Scheme, government expenditure increased 49.8% (again, compared with the previous year). By my reckoning that brings total government borrowing toward, and likely a little over, 100% of GDP. That hasn’t happened since 1963 when Cliff Richard’s Summer Holiday sat at the top of the singles charts.

Those numbers concern us, but we can’t claim to be overly concerned. The rapid deterioration in the public finances coincided with HM Treasury’s efforts to limit the hugely damaging impact of a public health disaster that is finite in nature. And, while there is plenty of room for argument about the efficacy of the government’s COVID-19 policy response (the ‘lockdown’), the course was set once businesses were mandated with closure – a large (and largely temporary) reduction in the tax take was inevitable and the Treasury was faced with what we consider to be a moral requirement to compensate business owners and to underpin wages. This is a run up in debt which is justified and necessary. Meanwhile, with interest rates as low as they are, it is a run up in debt which is mercifully manageable.
It is our contention that the British economy has now begun the process of recovery. The recession was short and sharp. It seems likely to me that GDP shrank by as much as 18% (give or take) during Q2. We’re guessing that the recovery is now underway and that real GDP will expand by as much as 13% (again, give or take a couple of percent) during Q3 with further gains in Q4.

We expect, in the loosest possible terms, that the full year will likely see a decline in real GDP of 9.0 or 10.0%, close to the 10.2% drop predicted by the IMF. We’re targeting expansion of ~6.0% next year.


Bank of England base rate

The Debt Management Office’s most recent quarterly review (for Q1 and published in May) values the total stock of conventional gilts at £1,164 billion with an average maturity at something like 14.5 years. Today, yields at the 14-15 year horizon stand at just 0.45%. The British government is able to borrow money at remarkably low rates. Indeed, during April, a £3.75 billion auction of gilts attracted a negative yield at minus 0.003% meaning that, for the first time in history, our government was paid to borrow money. That tranche had a maturity of 3 years, but the market rate for gilts already in issue have fallen further into negative territory since then. Yields are negative all the way out to maturities of up to 7 years and stand at just 0.2% even at the 10 year horizon.

Additionally, low interest rates are here to stay.

The Bank of England’s policy rate (Bank Rate) is currently set at 0.1%. We are not anticipating any change for at least the remainder of this year and very likely longer than that. In addition, we suspect that the Bank of England will sustain interference in the market – in the form of Quantitative Easing – for years to come and certainly for as long as it takes to foster a vigorous recovery in economic output.


UK Consumer Price Index (CPI)

Headline inflation is unlikely to trend higher in the near term. The Bank of England’s most recent assessment reflects their expectations for the year-on-year rate of increase in the Consumer Price Index (CPI) to average 0.6% over the course of 2020 – moving from 1.6% in January toward 0.0% by December – before charting a course to the 2.0% target in 2021 and averaging 2.0% in 2022.

We are aware that there are a number of investors concerned that today’s stimulus – both fiscal and monetary – might encourage high inflation in the long-run. That is a risk that we are alive to and we are watching the bond market closely. In our estimations, prices in the bond market are consistent with inflation which is a little above target three years hence.

Our best guess is that inflation remains reasonably well-behaved, with only a limited potential for year-on-year increases which exceed an upper limit of 3.0%.


with Peter Montague

The IMF is forecasting a similar drop across the Eurozone as the UK for this year – the aggregate comes in at -10.2%. If the IMF’s estimates are accurate, Italy and France will see declines of -12.8 and -12.5% respectively and which appear harsh alongside Germany’s projected fall of -7.8%. The French economy is forecast to recover 7.3% next year while Italy struggles to recoup 6.3% and Germany gains 5.4%.

The IMF expects the US economy to fall 8.0% this year and gain 4.5% next. We suspect the outcome of November’s presidential election will have an oversized influence on that front.

Japan is expected to weather the storm comparatively well, falling 5.8% this year, however next year’s forecasted 2.4% isn’t particularly inspiring. Chinese output is expected to increase at 1.0% this year and accelerate to 8.2% in 2021. India and Brazil see declines of 4.5% and 9.1% respectively with recoveries in the order of 6.0 and 3.6% next year

We are in the mature phase of the COVID-19 crisis. The early accelerating phase was apparent in and around March. Back then, we knew very little about the disease and, fearful that our health systems might be overwhelmed, we had no idea how long a deeply-damaging, all-encompassing lockdown might need to persist.

At the same time there was a good chance that our financial system might become dysfunctional.

Our understanding of the disease has progressed in great bounds since then. We now know much more about how our bodies are affected by the virus, we know who in society are most at risk, we are getting better at treating those most severely affected and there are several promising vaccines in advanced phases of development.

In the UK, and elsewhere, we are emerging from a general lockdown earlier than feared. And, while it seems likely that infection rates will increase again following eased restrictions, the high impact on economic activity associated with general lockdowns is now replaced with the lower impact associated with more targeted, local or sectoral lockdowns.

Of course, there will be setbacks along the way. And, even as a recovery takes hold, we will remain especially vulnerable to further shocks – both those which are rooted in the current crisis (a second wave of infections, rounds of bankruptcies, high unemployment, social unrest) and those which might emerge anew (geopolitical tensions with China) – for at least another year.


with Scott Mordrick, CFA

The portfolios remain comfortably ahead of their respective benchmarks over almost all time periods to date. There were some extremely strong gains seen by the portfolios during the second quarter of the year, with the best performers being those portfolios with the greatest allocation to growth assets.

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

  1. Our rebalancing at the middle and end of March helped performance in Q2. By rebalancing, we topped up those investments which had been hit hard by market volatility. The committee also increased risk at the end of March which helped.
  2. Underweight Property – the sector had a difficult Q2 due to the uncertainties regarding COVID19.
  3. Overweight Corporate Debt vs Government Debt. Corporate and High Yield bonds (to which the committee is both overweight) had a very strong quarter (far better than, for example, Gilts, to which the committee is underweight) as they rebounded following the falls seen in the first quarter.
  4. The performance of some of our regional equity funds, particularly those with a strong growth bias, as well as the strong performance of our two new Global Themed equity funds.

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

  1. UK Value managers, which still continued to struggle during the second quarter of the year.

Portfolio Changes

  1. At the end of April, the committee agreed to add the two global themed equity funds and fund this by reducing the allocation to US Equity, Asia Pacific Equity and Emerging Market Equity (in line with the geographical splits of the two themed equity funds). The committee also removed the Ninety One UK Special Situations fund, thereby reducing the allocation to UK Value Equity, from Neutral to Less Keen, and increasing the allocation, but retaining the same tactical view, to UK Large Cap equity and UK Small Cap Equity (in the more adventurous portfolios by adding the Octopus Micro Cap Growth fund).
  2. At the end of June, the committee agreed to replace the Kames Global Equity Market Neutral fund (as the management team left) with the Crabel Gemini fund. The committee further reduced the allocation to Asia Pacific Equity in favour of Emerging Markets equity (to reduce the overall exposure to China). The committee also slightly increased the allocation to Commodity, from Neutral to Like, and added the Impax Environmental Market fund.
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