How are managers positioning their portfolios in wake of Covid-19 crisis?

Covid-19 is an unprecedented problem for the global economy, and the associated market panic has, at times, led to trading conditions reminiscent of the Global Financial Crisis. 

The major central banks have pulled the trigger on some huge stimulus measures and governments have followed with fiscal policy but, in our view, most investors are still waiting for critical detail on support for businesses during the economic slump before they can begin to look through the volatility and bid the market.

So far our response has been to maintain the meaningful allocation to risk-free rates with which we began 2020 (of around 30%), while increasing the duration of this protective bucket to around 5.7 years as of March 17, and trimming certain credit positions. 

However, with the massive widening we have seen across the credit markets, yields and break-evens are now starting to look attractive to us. 

From here we would expect to begin selectively adding longer-dated and higher-yielding bonds in our favoured credit brackets in order to methodically increase our credit spread duration, while keeping a prudent allocation to cash to help maintain a high degree of liquidity.

It is very likely that markets will remain volatile, and market timing over the coming months is likely to be difficult for professional and retail investors alike. 

In the past two weeks the portfolio managers have raised some money from our corporate bond holdings within the HL Multi-Manager funds. 

Corporate bond funds have not been immune to the falls, but so far have held up much better than equities. We have raised this cash with a view to adding to equity positions when we believe the time is right to do so. 

Equities have fallen but they may well fall further from here. Government response to the crisis will be key to stem both economic concerns and the market downturn.

Cash is an attractive asset right now as it gives you options; once we get a better view on how individuals and businesses will be supported it will be easier to analyse the outlook and valuations.

As Covid-19 cases were initially concentrated in China we sought portfolio protection from a China-focused slowdown by adding short Australian dollar and long Japanese yen exposures, which contributed positively to performance. 

As the outbreak began to expand globally, we added a long-US large-cap put options strategy, bringing down our net equity exposure.

This strategy added significant value in February, then as options became more expensive we transitioned to achieving short exposure predominantly through index futures in order to continue to manage a low level of overall risk. 

The team continues to flexibly manage the fund’s positioning given the fast evolving environment. 

Due to the unknowns during a crisis, and in particular some of the short-term irrationality that becomes present in the market, it is seldom a time to make heroic swings of the investment bat.

As a result, when we do make changes our process tells us that communicating the path of travel to our clients and making small steps towards increasing or decreasing risk is the best method. 

During times of heightened volatility, we may add 1% or 2% to equities each month when we sense longer-term value.

While the coronavirus crisis is unique it does look like many other crises and therefore we are sticking to our investment process playbook for such situations. 

We feel equities are oversold on our longer-term metrics so have increased equity by 1% in our March asset allocation meeting ahead of further increases if equities continue to fall. 

By keeping a longer-term perspective, we are able to maintain a path through volatility while avoiding some of the behavioural biases that inevitably rear their heads at this time.

There have been huge swings in credit market prices over the past week and volatility has hit levels last seen in 2008 – even UK two-year yields turned negative.

Within financials, we tend to have more exposure to higher-yielding subordinated insurance, which suffered price falls last week. 

These are merely mark-to-market moves and fundamentally these are businesses with strong solvency and capital. 

The co-ordinated stimulus package from the Bank of England and the UK Government was not enough to lead to a contraction in spreads, but the European Central Bank has followed suit, announcing a number of accommodative measures, which should help keep businesses supported.

While we cannot forecast the outcome of Covid-19 and the oil price war, and things might get worse before they get better, we suspect central banks and governments will do as much as they can to avoid a banking crisis similar to the one we saw in 2008. 

Our fund has an underweight duration compared with peers and has done for a number of years, which has led to some short-term underperformance as gilt yields rallied to all-time lows. 

We have also let our cash levels build up and have invested in a number of low-duration assets, such as covered floating rate notes.

We started 2020 with a relatively optimistic outlook for the global economy. This optimism did not account for a global pandemic and Covid-19. 

We made material changes to our portfolios over the past few weeks given the deteriorating outlook. 

Most notably, we increased the size of our positions in US government bonds and Japanese yen while trimming risky assets.

It will be very difficult for risk assets to start to recover until we see a slowdown in the rate of spread of the virus, which would allow for a lifting of the current social distancing policies. 

In the meantime monetary policy needs to act to buy time, as we wait for the necessary fiscal and medical response. 

Central banks will reach for the existing playbook to help buy that time; given the uncertainties created by this pandemic they would be justified in going even further.

Markets will remain volatile in the near-term as the virus makes its way around the world. But, like previous crises have taught us, managing risk in order to stay invested is key to making it through the storm and out the other side. 

Eventually, markets will normalise and when they do we see attractive opportunities to generate returns.

We found the degree of complacency in stockmarkets quite perplexing. In the build-up to the correction, even as large-scale disruption in China became evident, investors effectively shrugged at the unfolding crisis.

We take a contrarian approach to investing and that is predicated on identifying situations where investors are not paying enough attention to 'risk' and have too much hope for 'reward'.  

We are trying to get the odds in our favour and we believe that serves us well during times like this.

The market's initial indifference is perhaps a symptom of a decade in which the 'Fed put' would ensure that winning trends kept on winning. 

That security blanket appears to be going up in flames. The resulting reaction looks like panic.

In light of the coronavirus crisis, we made some timely changes in advance of the correction. 

We increased exposure to investments with resilient revenues and downsized parts of the portfolio that are more economically sensitive.

Without further extraordinary interventions from central banks and politicians, the worst may be yet to come in the Western world. 

However, we will be looking out for signs that sentiment is ready to recover and will be ready to pick up attractively valued investment opportunities when they arise.

In the unprecedented times in which we find ourselves, we continue to run our model portfolios and multi-asset funds in line with our long-term strategic asset allocation, using tactical allocation to implement medium-term views. 

We are underweight equities and overweight fixed interest and absolute return, a decision which has been beneficial in the current volatile environment.

 

We will be increasing our exposure to fixed income and absolute return and will make discrete adjustments within our equity exposure, bolstering our cautious position.  

We have been in regular communication with our clients to reassure them during this worrying time; our key message is that it is unwise to make a knee-jerk reaction and that they should remain focused on their long-term investment goals. 

Central banks have acted swiftly cutting interest rates and the UK Government has pledged record-breaking stimulus to counteract the effects of the coronavirus, in order to support businesses and individuals. 

Maintaining ongoing and regular dialogue with clients will remain key as we navigate uncertain territory.