COVID-19 and Our Focus on the Fundamentals
By Bert Clark, President & CEO
The public health response to COVID-19 and governments’ unprecedented fiscal and monetary policy intervention have resulted in an extremely complex investment environment.
To generate outperformance in the near-to-medium term, investors and their partners will need to get the big things right amid stressed economic and market conditions. They need to figure out the impact of significant government intervention. And they need to identify ways in which their portfolio can take advantage of trends that accelerate or emerge from the COVID-19 crisis.
Getting the Big Things Right
COVID-19 has reinforced the importance of getting the big things right when it comes
to investing. At IMCO, this means combining a sophisticated approach to total
portfolio management with a fundamental approach at the asset class level.
We
are focused on six “big things”.
1. Asset class diversification
We help our clients build diversified portfolios that are designed to perform well over the long term in a range of macro-economic environments. This includes, for example, owning long nominal bonds to protect in times of market stress; investing in growth assets like credit and equity to generate returns in growth environments; and using real estate, infrastructure and inflation-linked bonds to perform in inflationary environments.
2. Ensuring adequate liquidity
Liquidity is king when markets are in turmoil. Having adequate liquidity avoids forced selling of growth assets in market downturns and allows opportunistic buying when they are relatively inexpensive. Institutions that have the courage and liquidity to be buyers when fear dominates the markets should succeed at preserving capital and enhancing long-term returns.
3. Strategic diversification
Inevitably, every investment strategy has periods of over- and underperformance. If investors are overly reliant on a single return-enhancing strategy (such as significantly overweighting one asset class or geography, or using significant amounts of leverage), then periods of underperformance can be extremely painful, and losses hard to recoup. We believe in pursuing diversified strategies for enhancing returns.
4. Targeted pursuit of net value add
In many public market segments, it is difficult to generate outperformance. We believe
that combining lower-cost passive, or factor-based, exposures, with more concentrated
exposures is an effective way to generate outperformance, net of fees.
A growing
number of institutional investors have added private markets to their strategic asset
mix, eroding the illiquidity premium that private assets offer. Today, investing in
private markets makes sense only where value enhancement opportunities exist that are
not possible in a public market context. Asset owners and managers with real
operational expertise have an advantage.
5. Controlling costs
Costs are one of the few things an investor can control. Costs should be a key area of
focus for any well-run organization. This means using scale and market presence to
negotiate better fees from external managers. It means only pursuing higher-cost
active strategies in market segments where they have a good chance of adding value. It
also means internalizing investment activities where equivalent results can be
generated at a lower cost.
Building an organization that can manage liquidity,
partner with external managers on an efficient basis, and properly structure asset
classes requires scale. Size matters when it comes to costs and so smaller
organizations should to consider consolidating asset management efforts.
6. Navigating trends
Powerful trends may be obvious but positioning investment portfolios to avoid or benefit from them takes discipline. For example, the rise of online shopping was evident, but having the discipline to reduce retail real estate holdings before this trend really started to hurt real estate valuations was not common. Today, the decarbonization initiatives required to deal with the threat of global warming pose the same kind of challenges. Having the discipline to get ahead of climate-related risks and see emerging opportunities will take discipline.
Navigating Today’s Markets
The long-term impacts of COVID-19 on markets and the global economy are not yet clear. To minimize risks and benefit from opportunities in these uncertain times, it is key to get the big things right.
Investors should rebalance their portfolios (which may mean systematically buying public equities) to prepare for various scenarios: the possibility that the economy will recover relatively quickly, and the possibility of significant and lasting damage to certain segments. Rebalancing, coupled with strong liquidity management, allows investors to obtain growth assets at lower valuations than we have seen in some time.
Investors should assess the expected risk/return characteristics of all asset classes in stressed macro-economic environments. They should modestly tilt their asset mix in the direction of asset classes with the best opportunities, on a risk-adjusted basis.
Investors should also consider pursuing net value add within asset classes in a very targeted way, based on their own strong competitive advantage or that of their partners. Today we believe that a competitive advantage in navigating stressed economic environments combined with unprecedented public policy actions will give well-positioned investors an opportunity to outperform.
While the S&P has bounced back considerably from its March low, we do not see global economic growth returning to pre-March 2020 levels this year. Some effects of the COVID-19 crisis are certain to be felt well into 2021, if not longer.
This investment environment is made more complex by the extraordinary fiscal and monetary policy intervention that governments have taken to contain COVID-19. Governments have lowered policy interest rates, established direct lending facilities for businesses and direct wage subsidies for workers, pressured banks to lower consumer credit card rates, intervened in the debt capital markets and agreed to bail out certain industries. The speed, breadth and magnitude of these actions are unprecedented. Market volatility is incredibly high in this environment and opportunities may not persist.
Generating outperformance over the near to medium term therefore requires expertise operating in a stressed economic environment, combined with expertise in understanding the potential effects of unprecedented government intervention.
Our View on the Big Trends
Powerful trends were underway before COVID-19 (e.g., a lower-for-longer rate environment, deceleration in globalization, ongoing central bank involvement in capital markets, dominance of larger companies, increased online commerce and a shift to remote working). Investors now need to consider how these trends may accelerate, and where the risks and opportunities lie.
Before the COVID-19 outbreak, demographic trends in the largest economies and high corporate and individual indebtedness, among other factors, seemed very likely to suppress interest rates and future returns from most asset classes. We believe that the economic downturn resulting from COVID-19 will result in lower economic growth for some time and inflict real economic damage on many companies and industries.
Slowing globalization began before the COVID-19 outbreak. This trend may accelerate as some governments have closed borders to contain the virus, and companies and countries are assessing supply chain vulnerabilities.
Investors might not accurately predict the speed or full impact of these trends, but we must keep a careful eye on them, and position accordingly.