When markets tank, and subsequently rebound somewhat, the broad questions investors will ask are what they should have done during the rout and what they should do once it’s run. The coronavirus pandemic has wreaked havoc across global equity and fixed-income markets, with uncertainty about the future economic fallout only adding to investors’ anxiety. But one global piece of advice from various fund managers ring clear during tumultuous times: Stick to your initial investment strategy. Where such a strategy included exposure to offshore assets, whether shares or bonds, the same advice applies.
“The foundation of any investment strategy starts with the right long-term structure based on your time horizon and risk profile,” says Anet Ahern, CEO of PSG Asset Management. “If that was inappropriate to start with, it is much more difficult to navigate the current situation.” And difficult the current situation is. The MSCI World Index, which tracks 1 643 stocks from 23 developed countries, declined by as much as 31.8% since the beginning of the year before rebounding 24.3% to settle at 15.2% down for the year by the time of writing (see table on p.31).
The MSCI Emerging Markets Index, which constitutes 1 404 stocks from 26 emerging countries, dropped 32% during the initial sell-off since the beginning of the year and subsequently rebounded by 16% for a year-to-date return of -21.1%. These are, however, general indices and most fund managers follow a bottom-up approach to stock selection. As in any portfolio, it is wise to have some form of protection against extreme market events, such as the current coronavirus pandemic.
During periods of heightened volatility, everything – except dollar cash – seems to fall, cheap assets get cheaper and usually non- correlated sectors sell off in tandem, explains Ahern. This makes investors doubt the principle of a diversified portfolio, she says. “The pain of opening the latest statement and seeing your assets decline, even if only on paper, induces the temptation to move to cash,” Ahern says. The best hedge for most investors remains correct risk profiling and diversification, she says.
Building in protection
Most funds utilise strategies to hedge themselves. That is also the case with offshore funds where the volatility of the rand can either boost a portfolio or diminish it in a heartbeat. There are several strategies that can be used to hedge against market downturns too. This varies from put options, put spreads and fences that offset the downside in risk assets such as equities and bonds, says Kurt Benn, head of the balanced franchise at Absa Asset Management. “Rand hedge strategies are the cheapest and arguably the most effective strategy, especially when applied to developed market bonds,” he says. “This is generally the safe-haven asset class of choice when investors get fearful.”
In times of market stress there “is no substitute for high-quality government bonds”, says Michael Adsetts, deputy chief investment officer at Momentum Investments. “In equity market sell-offs, prevailing yields tend to fall, and the price of these instruments goes up.” The S&P Global Developed Sovereign Bond Index, which includes locally-denominated government debt in developed countries, returned 2.06% since the beginning of the year. The S&P 500 Bond Index, which tracks the corporate debt of the constituents of the S&P 500 Index in the US, returned 2.3% this year.
It is noticeable that this index fell by 13.6% between 6 March and 19 March to reach a low of 445.3 points on the latter date. It has risen by 12.5% since. “The issue with these securities – such as US Treasuries and UK gilts – is that as prevailing yields are low, they look pretty expensive most of the time,” Adsetts says. “The diversification benefit for a portfolio is huge, however, so you have to look at them as a form of portfolio insurance. A little expensive to own when things are going well but you will be glad you had them when the going gets tough.”
Christo Lineveldt, investment specialist at Coronation Fund Managers, also touts the benefits of diversification, especially before a market event such as the coronavirus sell-off. Diversification is an essential strategy when constructing robust portfolios. However, one of the unique features of the coronavirus pandemic rout has been the universal sell-off of almost all asset classes, even gold, he explains. “Only cash and developed market bonds managed to preserve capital,” he says.
Shifting to cash
As investors piled into fixed-income assets, both offshore and locally, the question arose whether this move benefits them. “If you’re a long-term investor, then absolutely not,” says Lineveldt. “Shifting from risk assets to fixed- income assets implies an attempt at timing, and timing the markets successfully is near impossible in a normal environment, not to mention during a crisis.”
The shift out of equities into fixed-income assets was driven purely by fear, says Arno Lawrenz, global investment strategist at Ashburton Investments. “Given that the Covid-19 pandemic was of necessity a completely unknown factor, this meant that the ramifications – both economically and in a healthcare sense – would be similarly completely unknown,” he says. “Accordingly, faced with not just uncertainty, but with complete lack of knowledge, one could argue whether selling equities and buying fixed income was a rational thing to do.”
Taking the decision to move your funds from equities to fixed-income assets may, in addition to doing it without sufficient knowledge and amid uncertainty, lead to permanent losses. “The primary effect of moving from shares into fixed income during a market downturn is that it can turn a temporary loss into a permanent one,” says Sangeeth Sewnath, deputy managing director of Ninety One (previously Investec Asset Management). “While the return from fixed income at that point in the market seems tempting, it is almost inevitably lower than the potential return as equity markets digest information calmly and return to normality.”
Many believe that that they will be able to step out of the market temporarily and return, but the reality is that while it is very easy to discern the points at which to return in retrospect, it is almost impossible to do so at the time of exit, he says. Joao Frasco, chief investment officer at Stanlib Multi-Manager, shares a similar sentiment. “Most people never got this timing right, and certainly never ended up protecting capital in the process if they moved to bonds with substantial duration,” he says.
On the other hand, a move into shorter duration assets, with less interest rate risk, would have been the best strategy, he says. “But again, it required perfect market timing, not only in getting out of risky assets, but also getting back in. US Treasuries were the exception as they remain a ‘safe haven’ during times of market uncertainty,” Frasco says.
This is an extract of the cover story that originally appeared in the 7 May edition of finweek. For the full story, you can buy and download the magazine here.