Coronavirus: Responses to markets and portfolio actions

In the US, however, the story is somewhat different, with an alarming surge in new cases. The world’s largest economy was slow to lockdown its population – still failing to do so in some areas – leading to a rapidly rising number of new infections and deaths.

Outlook for the economy and markets:

• Downturn in Q2 across all regions
  o   Expected to be twice as bad as the financial crisis
• China is putting its factories back to work, having well-contained the virus
  o   Chinese equities have outperformed
  o   Exports are expected to remain weaker, due to much lower global demand
• Central banks and governments have stepped in to provide huge amounts of support
  o   Aim is to freeze much of the global economy until Covid-19 has been contained then reignite, hoping to it has not sustained too much damage
  o   UK and US bond yields have fallen on virtually unlimited QE
• High yield and investment grade spreads over government bonds have begun to narrow from pushing out wide as Covid-19 spread
  o   Markets expect government support will prevent mass defaults on bonds and loans

Focus on alternatives

We believe including alternatives in an institutional, long-term portfolio helps diversify risk factors across your holdings. This can help create a robust portfolio that is more resilient to challenging markets, such as the current one.

We have been diversifying our portfolios for some time, with a range of alternatives, including hedge funds and private market strategies.

Note the following aims within our use of alternatives:

• Spread risk to help cushion losses elsewhere in portfolio
• Gain exposure to non-traditional risk and return drivers
• Employ tail risk hedging strategies, which tend to perform when risk assets do not
• Allocate to insurance linked strategies, such as bonds linked to natural disaster, as a non-correlated return-driver

Allocating to alternatives does have its challenges, however as some hedge funds, for example, are not as hedged as they might sound, and are therefore not immune to the type of markets we have seen recently.

It is important to forensically check whether the investment outcome you receive is the one you expected in this or any other scenario, and compare all manager returns to their peers, rather than the general market.

Private Markets

Investors in private market assets will have to wait for the regular valuation schedule to see how their portfolios have been affected. For Q1 valuations, this will likely be in May, Q2 valuations will likely be in August.

While not being marked-to-market insulates these assets from some initial public market volatility, it is certain that these assets will not be immune to the impact of the Covid-19 outbreak.

We can look at the 2008-9 financial crisis for context – and to find opportunity:

• Private equity fell on average 20% over the 12 months to Q3 2019; public markets fell more than 30% over this period (Source: Preqin, March 2020)
• The private market fundraising tends to be cyclical and usually linked to the economic cycle
• IRR on vintages coinciding with crisis years generally outperform*; opportunities may lie ahead
• Wider dispersions between best and worst performing managers in private market strategies, so manager selection is particularly important*.

Private Market strategies in focus

Private equity – Working capital and cash flow will be crucial over the next few months. We expect to see a continuation of capital calls in the near to cover portfolio company financing needs and to pay down any fund level credit facility borrowing. We believe there will be lower distributions as IPOs and exits are delayed. In our view, there will be significant opportunities to put capital to work in the secondary market in the quarters ahead. 

Private debt – With the severity of the crisis, we are of opinion that a wave of defaults is likely to lie ahead, with some sectors likely to be more impacted than others. We think investors could find cushioning through diversified portfolios and via holding senior tranches of issuances.

Infrastructure – This crisis will be a test for an asset class that has become increasingly popular since the last global crisis. Impact on the asset will depend on the sector, meaning potentially wide dispersion of outcomes.

Real estate – Rental growth will be significantly impacted, with significant disruption in the sector. But low interest rates environments are usually positive for this asset class, so there may be opportunities. 

With all private markets, we believe - and undertake - a consistent allocation approach to build up our client portfolios over time.

What’s next?

Market volatility is here to stay, in our view, at least until the Covid-19 virus is contained globally. We expect there to be investment opportunities arising from the current market dislocations.

We believe managers with a long-term view – especially those in private markets – may have the opportunity to weather the current storm to help dampen overall risk and achieve their financial goals efficiently.

View our Important Notices

Previous webinar update

Thursday, 26 March 2020