June 2020 investment update

• Equity valuations appear nonsensical and government bond yields are non-existent
• Finding lower risk securities that have a positive real return is proving increasingly challenging
• As a result, we maintain our below neutral allocation to equities and seek exposure through single stocks instead

Sometimes investors are so focused in the rear view mirror, they fail to see the bumps in the road ahead. The disconnect between the macro-economic environment and markets has to reconnect at some point and when it does, it is unlikely to be in an orderly fashion.

Our focus has not changed. We are not trying to chase markets higher but to deliver consistent and real returns for our clients. As a result, we maintain our below neutral allocation to equities.

“We have had to not only tweak our allocations, but to fundamentally change our investment strategy.”

Traditional asset classes boundaries are breaking down. We have had to not only tweak our allocations, but to fundamentally change our investment strategy over the last three months because the economic and subsequent market environment has shifted dramatically.

Index exposure has generated good returns in the last couple of months with the rising stimulus tide pushing almost all stocks higher. However, as we get further into the unlocking phase and the government life support starts to be removed, we will again see huge discrepancies between index performance and basket performance. This is a market for selective deployment, being nimble and having conviction in your ideas.

One growing dilemma for clients is this question of ‘where can I generate real returns with low risk and low volatility?’ The starting point for almost every private client, is to find lower risk securities that have a positive real return and this is proving to be increasingly challenging. The breaking down of traditional asset class boundaries within this ZIRP (zero interest rate policy) world must apply to sub-asset classes as well.

“You are forced to either accept a lower return with the same risk, or to seek the same return with now a higher level of risk.”

Government bonds used to provide safety and return. Now only the former is available – so where do you seek the latter? Yields on investment grade bonds are a spread over government yields, so as government bond yields have collapsed along with interest rates, you are forced to either accept a lower return with the same risk, or to seek the same return with now a higher level of risk.

The same applies to equities. In a normalised environment investors have been prepared to pay an average of $15 per $1 of earnings. In the wave of the unfurling Covid-19 pandemic and with the macro economic uncertainty, how should this impact what investors are prepared to pay? I would expect this to be even lower but given the market rally over the last couple of months, this now sits at $22.5 per $1 of earnings.

There are a few potential reasons for this; people are now prepared to pay more for future earnings, there are a lack of real return generating alternatives and investors do not care about valuations due to the support of governments and central banks around the world.

“We have now started deploying into our coronavirus recovery basket.”

So what does a ‘post-Covid-19’ world look like from an investor’s perspective? Historic asset class barriers are going to have to fall away as portfolios will need to better incorporate the opportunities around them. There remain too many unknowns – and many of them are providing additional risks on the downside – which in combination with high equity valuations has meant that we are comfortable with our single stock exposure that provides us indirect access to ongoing consumer spending.

We believe that higher volatility is coming, and with it interesting new investment opportunities. While valuations appear nonsensical and government bond yields are non-existent, we continue to look for value and opportunities for our clients.