UK fund selectors give their unique take on the rapidly evolving global coronavirus crisis from a professional and personal perspective. Today we speak to Dan Kemp, chief investment officer, EMEA at Morningstar Investment Management Europe.
How does the market fallout from the coronavirus pandemic compare with other tough times during your career? Are there lessons you have learnt during your career that can help you now?
The recent market turmoil would represent the fourth major crash of my career and while the cause and exact path of each crash is unique, we should keep in mind they are really a normal part of the market cycle and share similar characteristics. The most important of these is their impact on investor behaviour. When faced with a crisis, people tend to narrow their focus and shorten their investment horizon leading to predictable mistakes. A crash can provide a great opportunity to improve the long-term returns of a portfolio but to do so, portfolio managers must be able to lift their attention from the daily news flow and focus on the long-term prospects for asset classes.
What are the key pieces of data or commentary you are looking at to help you analyse the situation?
The current price of assets compared to a reasonable assessment of their fair value is the most important information for investors at any point in the market cycle. However, it is especially important during market crashes, as it provides an anchor for our analysis and helps us remain focused on the long term. Without the consistency of a strong valuation framework, there is a temptation for investors to become amateur experts in the subject that is driving markets in the short term and ignore the key drivers of long-term returns. While this temptation is always present, it is especially prevalent during a crash. This new-found ‘expertise' can lead to over-confidence, which can diminish investors' long term returns and increase risk.
What shifts have you made on portfolios since the crisis intensified? How are you protecting portfolios and where are the opportunities?
When reviewing changes to a portfolio, the starting point is always important. We entered this period concerned about the high prices in some asset classes and hence were somewhat defensively positioned. Consequently, the portfolios have behaved in line with our expectations, and we have avoided the need to cut risk in a falling market. And so, our first action was to rebalance portfolios to ensure that our exposure to risk assets did not fall as they became cheaper. More recently we have been adding to our equity exposure as the price of some assets, such as UK equities, look unusually attractive.
Having added risk to portfolios, the next step is to update or initiate research on those assets that have suffered the greatest price falls and compare the returns implied by their current prices to the return we would expect from those assets over the long term. We have around 100 people in the Morningstar Investment Management team, in addition to fund, equity, and credit analysts. We are therefore able to cover a lot of ground quickly and in depth. This fundamental analysis helps us understand whether other market participants have become overly pessimistic and, in doing so, have created opportunity for investors who are prepared to take a longer-term perspective and act independently from the herd. Global energy, European financials, and high-yield credit are all catching our attention as potential opportunities to deliver strong returns in the future. In the US, we've been adding broad exposures in some cases because everything had fallen so much.
What are fund managers saying to you about their biggest challenges and opportunities at the moment?
Liquidity in fixed income markets has clearly been a challenge for fund managers in both the active and passive environments. Illiquidity increases the cost of trading, makes it more difficult for fund managers to adjust positions and encourages investors to pay a premium for the most liquid securities. While this is clearly problematic for investors that bought illiquid holdings at a much higher price, it may provide an opportunity for investors that are prepared to take a contrarian approach, as they are being rewarded for taking illiquidity risk. The drawback of this approach is that illiquidity is incompatible with daily traded funds and so the ability of investors to access that illiquidity premium in traditional funds is limited.
How are you communicating with clients or advisers at this time? How are you adjusting to you and your teams working from home? What practical tips would you share for working in this way?
As part of a global investment management team, we regularly communicate with colleagues from home, and we are fortunate to have the technology to enable us to do this. Consequently, the transition to the new working environment was seamless. However, balancing work and childcare responsibilities was clearly a challenge for the parents in our team, so we implemented a new timetable that includes several meeting blackout periods. These are designed to coincide with the times that young children need to be fed, exercised, or prepared for bed. This supports home-schooling by removing parents' need to choose between their children and their work.
From a client perspective, our focus at Morningstar is to support advisers to help investors make good financial decisions. We need to raise our support and have significantly increased our delivery of content to advisers. This includes a weekly webinar where our investment team address key questions from advisers.
And finally, what is helping you get through the weeks at home?
Being at home so much has reduced my interaction with loads of people but has greatly increased time shared with those who matter most to me. The opportunity to enjoy three meals a day and exercise time with my children feels like an incredible gift and is a real benefit of the current situation. Eating supper as a family is leading us to spend more of the evening together which I'm really enjoying (but my children may give you a different view!). Alongside that, we are enormously fortunate to have a garden, so the ability to work outside in the glorious spring weather is another highlight. As we think about the overall impact of Covid-19 it seems to me that while it can have a devastating effect on individuals and families, some of the changes it is forcing on society may be more positive in the long run.