At the half way stage of 2020 we reflect on the previous six months and how this has impacted our portfolios. We have been rewarded with relative outperformance for defensive positioning and believe this remains appropriate given the uncertainty in which we operate.
What has happened so far this year?
Coronavirus had a rapid global impact and forced many countries into lockdown. Financial markets fell sharply as they appraised the risk to economic growth and corporate earnings. The one-way traffic of selling without buying created a supply surge in equities and bonds which only served to worsen market volatility. A key factor in market sell-offs, which is often underappreciated in such events, is how market functionality deteriorates and makes falling prices fall further. We saw this in every corner of the market. Even US government bonds suffered in this market breakdown. As such, financial assets were left battered and bruised by mid-March and it looked like financial Armageddon.
Then central banks stepped in. They implemented huge stimulus at incredible pace. There were emergency rate cuts and Quantitative Easing (QE) globally. The US Federal Reserve recognised what was happening, so first and foremost provided support for markets to begin to function again. Other central banks were also reacting to the turmoil. The Bank of England cut rates and increased QE, and the European Central Bank (ECB) also restarted QE. Central banks have since started buying corporate debt which has also helped reflate asset prices. Governments did their bit too; the UK government introduced the Job Retention Scheme to enable employers to furlough staff, and the US increased unemployment benefits. Both programs will have gone a long way to supporting the consumer, a large part of both economies.
With markets falling all around us, our portfolios were not immune. It is hard to defy gravity in such circumstances. But relative to benchmarks, we have been satisfied with how our portfolios traversed the upheaval. We are leading the peer groups over the short and long term (6 months to 10 years); we don’t win all the time but we think our approach has helped us achieve strong results over the long term.
Data correct as at 1st July 2020.
How did GDIM achieve relative outperformance through the volatile markets in 2020?
If changes are needed during volatile periods, it is likely already too late to implement these. In early 2019 we predicted that there would be more frequent bouts of volatility following market turbulence at the end of 2018, that economic growth was already faltering, and corporate margins were coming under pressure. We saw that our portfolios needed more protection from these volatile market events. On completing a research project, we included government bonds within our fixed income in portfolios, as these appeared to be the most reliable assets for this purpose, as they have consistently provided protection in such events historically. These assets did a lot of heavy lifting in February and March this year, protecting portfolios from the worst of the falls. We didn’t predict Covid-19, but our forward thinking set us in good stead for what was to come, regardless of the catalyst. Government bonds were not our only risk hedges; we hold some strategic bond funds with capabilities in derivatives and shorting which we do not have direct access to in portfolios to add protection against risk. Equity puts and credit default swaps provided a great deal of inverse positive performance through February and March.
Although we are pleased with what has happened so far, we are not complacent. We continue to focus on what lies ahead and scrutinise portfolios to ensure they are appropriately positioned for our outlook. It is likely that these defensive positions will remain in portfolios for the foreseeable future as we still expect more frequent volatile market events. There does appear to be signs of recovery in parts of the world, but these are not solid foundations just yet. It is prudent to have this defence in case recovery does not materialise soon, especially as we see little room for these positions to detract meaningfully from upside capture. We will actively increase and reduce exposure to these assets depending on how our outlook develops, and we will take opportunities as we see them. However, capital preservation remains of paramount importance in our most defensive portfolios,
Beyond our defensive positions, our equity funds also performed better than their country indices and respective benchmarks. We have a distinctive style in our equity selection; we typically avoid value stocks, as these types of companies could come under stress from high debt levels, or because their revenue streams are dictated by the economic cycle. Instead we look for companies with pricing power, resilient financial positions, strong cash flow generation, high return on equity, and which operate in structural growth trends with visible runways for growth. We expect this combination of defensive positions in fixed income, and tomorrow’s winners in equity growth to continue to leave us in good stead, whatever markets do next.
Benjamin Benson IMC
Investment Manager
