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2020 has been a whirlwind so far, and as we enter the back straight it likely has a few stings in its tail for us. While the third quarter was broadly positive from an equity market perspective, we saw the ‘rally of optimism’ start to fade in September. I am not sure what we will run out of first – governments’ appetite for supporting industries and employees or investors patience.
One of the key reasons why we created our discretionary model portfolios with a focus on absolute return, is our client’s expectations. Very few clients think of their target return relative to the performance of underlying equity and bond indices. The majority thinking in terms of ‘beating inflation’ to maintain the real value ‘and then a little bit on top’, and this latter part is driven by their risk profile. This concept of absolute returns is going to be a key challenge in the years to come – whilst we have set something of a rod for our own backs, we have done this purely in the best interest of our clients. There will be many investment managers who will continue with their relative return mandate and expect clients to be satisfied when they have lost less money than the relative benchmark has indicated that they ‘should have’ done.
It is getting consistently harder to incorporate balance into model portfolios. With short dated government bonds yielding next to nothing, the decision on government bond weighting (providing downside protection but at the cost of a substantial performance drag) is key. On the other hand, generating positive real returns in fixed income in the current zero interest rate environment results requires specialists that can pick and choose amongst the lower rated BBB to B companies, extending duration, and timing entry and exit points, all in a time of heightened economic uncertainty. The additional challenge for EUR denominated investors, where interest rates remain negative, is that there are very few liquid investment grade corporate bonds that have a positive nominal yield. When you consider management fees, execution costs and inflation,the decision to buy a negative real yielding fixed income instrument is tricky.
On the equity side a similar approach is required. Simply buying index trackers is unlikely to generate you much real return over the coming three to five years given the valuations at the start of your investment. Selection of equity investments (which stocks,sectors, styles and regions) and the timing of those purchases is going to be key over the coming years. Whilst technology has been the go-to winning sector for the last decade, I feel that a large part of that race has already been won. The FAANGs (Facebook, Amazon, Apple, Netlifx, Google) have limited upside from here, not least due to their sheer size – you can’t increase market share by much when you are already most of the market.
From Dolfin’s perspective,this is where the thematic investing comes into its own. Having deployed our Covid-19 strategy successfully between April and June (albeit with low amounts of equity exposure) we are already formulating our strategy for 2021 and beyond. The ‘new normal’ that many are talking about is already here. Whilst the US election will take a generate of headlines over the next quarter, there are bigger movements that are happening which I suspect will generate more returns rather than trying to strategize around the outcome.
One thing we are closely monitoring is unemployment. Governments around the world have come up with several inventive schemes and initiatives to try and keep the unemployment number artificially lower, or to keep the unemployed temporarily solvent. Ultimately it revolves around the same concept – the Government paying people money to not do a job. In the UK the furlough scheme has seen 9.6m employees furloughed at a cost of a little under £40bn as at 20th September (versus a total labour force size of 33m people leaving almost 30% of the work force currently furloughed. Whilst this doesn’t show up in the unemployment rate, the stark contrast between the decline in hours worked due to the 2008 global financial crisis versus the Covid-19 economic shut down is clear. Both recessions created very different challenges for governments, businesses and consumers.
The UK Chancellor recently proposed increasing the loan scheme for large businesses to “all viable firms” – although the most interesting part of the whole announcement centres on the word ‘viable’. I believe that there are large numbers of firms that were viable pre-March 2020 which no longer are. This is not down to the virus directly, but more the permanent change in consumption and lifestyle caused by the virus. Attitudes towards central city living, commuting, full time office working, retail shopping and so on have changed markedly. I don’t see them changing back because businesses, workers and ultimately consumers have realised what is possible.
Winners like Ocado and Amazon (both of which we own in different model portfolios) have thrived because they enable consumers to shop from the comfort of their homes. Video gaming has undergone a complete transformation from something played by ‘geeks’ and ‘nerds’ to a social (yet socially distanced) activity played by friends – or indeed trips to a VR world experience with colleagues.
This raises a number of questions. What happens to face-to-face social activities? Are we destined to spend the rest of our lives cooped up in our homes, communicating electronically with each other? How long will bars have to enforced socially distanced drinking, QR code scanning and ordering drinks by an app? When will the government move from ‘prevention mode’ to ‘acceptance mode’ with regards to Covid-19?
In my last Letter to Investors I suspected that this one would also be written from home. Whilst I, and a small number of colleagues, have started venturing back into the office a couple of days a week, we remain predominantly working from home and anticipate this to be the case for the rest of 2020.
Past performance is not a reliable indicator of future returns. Forecasts are not a reliable indicator of future returns. If the information is not listed in your base currency, then the result may increase or decrease due to currency fluctuations.
If not otherwise indicated, all graphs are sourced from Dolfin research, October 2020.
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