Keep calm to combat corona crunch: five fund experts on how to play the sell-off

Our experts, caught off guard, have jumped into action.

Financial markets hate uncertainty but the global pandemic has taken uncertainty levels to fever pitch. “We have plunged into the Valley of Darkness, and we don’t know how long we are going to be there,” warns Richard Dunbar at Aberdeen Standard. “But we can be sure that when we finally emerge, the landscape is going to be different.”

The coronavirus crash came as a genuine bolt from the blue. Like just about everyone else, our asset allocation panellists were completely wrong-footed by it and have been on a steep learning curve ever since. The precipitous nature of the fall – the UK’s broadly based FTSE All-share index fell by 37% between 17 January and the low point on 23 March – left everyone caught in the headlights.

There had been warning signs aplenty: earlier virus outbreaks such as the 2002-04 Sars and the 2009 swine flu contagions, as well as apocalyptic noises from the likes of Microsoft founder Bill Gates (as long ago as 2005) and Barack Obama’s former Treasury secretary Larry Summers (in 2016). These were largely ignored. Even in late January, optimistic global wealth managers were still filling their boots with equities. The Bank of America survey of more than 200 managers showed their cash positions still running at their lowest levels for seven years.

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Close to the edge

To be fair to our panel members, they entered 2020 in a cautious mood, highlighting a number of potential ‘canaries in the coal mine’. But they could not resist the pressure to follow the crowd.

Thus, the panel’s average scores for all equity sectors except the US edged higher in the previous review. Across all sectors in February it was 5.9 (5.4 in November). In contrast, average scores in government bonds offering protection in a downturn slipped from 4.1 to 3.8.

“We felt the markets were a bit frothy, but nobody expected this,” says Chris Wyllie at Connor Broadley. “This is the flaw in the wealth management business: a sudden relapse in the markets and you cannot sell because liquidity dries up.” Keith Wade at Schroders agrees: “Given the amount of money we manage, we cannot sell when markets move as quickly as this, even if we want to.”

The panel’s experience highlights a major lesson for investors to learn from the setback: the huge defensive merits of spreading risk across a range of global markets and different sectors. Sector performance figures according to the Investment Association (IA) show that in the first quarter funds invested exclusively in UK shares fell on average by nearly a third. Other global equity funds fared less badly, however: the IA North America, emerging market and Japan sectors lost around a fifth of their value. Technology stocks held up relatively well, but smaller company funds around the world all proved vulnerable.

In contrast, UK gilt funds gained nearly 6%, while strategic bond funds limited average losses to 6.5%. Dunbar says: “Bonds never looked cheap, but I am glad I had some.”

Inevitably, there has now been a more defensive reshaping of the asset allocation mix. But it has not been as radical as some might have expected, given the severity of the crisis and the level of uncertainty it has generated.

Our scorecard shows average increases in cash holdings, more exposure to government bonds and the emergence of corporate bonds as a favoured sector. In most cases, equity market scores have been tweaked downwards, but not by much. Scores for the UK and Japan remain mostly neutral or overweight, while US shares have drifted back into favour a smidgeon because of their defensive attractions.

Our fund managers are conflicted. The immediate outlook is grim: a possible 20% contraction in the economies of developed countries over the current quarter (April-June) as the pandemic lockdown causes massive demand destruction. However, Monique Wong at Coutts says: “I cannot imagine we won’t get through this crisis, and we have seen how swiftly the mood in markets can change.”

Eye on equities

Wong has increased her cash holdings but doesn’t want to miss out if equities recover. She sees little value in government bonds – where she is underweight – and much more promise in equities.

She says: “If you are a long-term investor, you would be looking to deploy that cash into equities and other risk assets in a measured fashion. Equities seem to be finding a floor, helped by massive support programmes by governments and central banks, and signs that the virus may be reaching a peak.” But in the meantime, she has lowered her scores for all equity sectors except the US.

Dunbar remains “slightly overweight in equities and slightly risk-facing” in his approach. He has left his scores unchanged for UK, Japanese and European equities but lowered his exposure to emerging markets. However, he has raised his score for US equities to 7. He remains underweight in government bonds.

He says: “I am not clever enough to duck and dive in these volatile conditions. Our emphasis will be on larger-cap companies with healthy balance sheets and lower volatility.”

Wyllie takes the optimistic view that the pandemic will prove “a relatively short-term event”. He believes a proper lockdown will prove effective, while improvements in testing, diagnosis and treatments continue. He adds: “We know we cannot keep a lockdown running for more than 12 weeks without it having a ruinous impact on the economy. And no one knows what the economic drag will be once we start going back to work.”

Bond bastion

His strategy is to sharply raise his exposure to government bonds. He prefers to hold US Treasury bonds and has raised his global bond score from 4 to 7. His score for UK gilts jumps from 2 to 5. In equities, Wyllie keeps his scores unchanged, except in the US where, like Dunbar, he is raising his exposure.

Wyllie says: “A lot of people are worried about a deep recession turning into a depression, but we might get the opposite: an enormous bounce-back, euphoric relief and then runaway inflation. In the 1930s, a recession turned into a depression because of government policy mistakes, but governments and central banks are bending over backwards to help – throwing the kitchen sink at the crisis.”

Wade admits the panel went into the recent meltdown “with more in equities than we would have liked, although we had lightened our holdings, and we also held gold and 30-year US Treasury bonds, as well as safe-haven currencies such as the yen that cushion the blow.”

Like Wyllie, he believes the crisis is not going to last and anticipates a bounce-back. He says: “We have assumed in our forecasts that the world economy takes a big hit in the second quarter, and then bounces back as people go back to work in the third quarter; we as investors can then respond to the stimulus provided by governments and central banks.”

Pervasive uncertainty

Wade is, however, well aware that the virus may come back and produce “a series of aftershocks next winter”. He warns that it may be another year before the crisis is fully over.

“It may well take that long to get us all vaccinated so that we can really get back to work,” he says. “The markets have priced in a recession, but they do not appear to be pricing in a long period of uncertainty banks and governments are going to have to navigate so we have an economy that can recover.”

That’s why he remains cautious. However, he now feels value has returned to markets. He is neutral overall on equities. He has kept his US score unchanged at 6 and his UK score at 5. He has offset that by cutting his scores for both Europe and emerging markets to 4. He explains: “We are biased towards quality and towards the technology sector, which is probably better placed than other areas to cope with the crisis. That is why our emphasis is on the US.”

Rob Burdett at BMO had one advantage over the rest of the panel coming into the recent meltdown: he had raised his cash score to 9. He has now turned even more defensive by raising his score for bonds and his score for cash to 10, the maximum. He remains underweight in US equities, and has lowered his scores for Europe and emerging markets.

He admits: “Our cash position did help us through the crisis, but pretty much every other judgement was wrong. We needed to be in bonds and gold as well as cash – and that was not quite where we were.” He thinks it may take more than three months to get through this correction. “There is room for a further leg-down in equities. The lockdown is being extended for longer than expected. There are bankruptcies by the day and dividend suspensions, and in the aftermath, there will be corporate restructuring and probably higher taxes.”

Nevertheless, Burdett remains loyal to his favourite equity market, Japan – up goes the score here from 7 to 8 – and he is still doggedly overweight in UK equities. “I would not sell now, despite the UK’s massive underperformance against other markets,” he says. “I don’t think the virus has hit the UK more than anywhere else. The weakness of the pound against almost every other currency makes the UK even more competitive internationally.”

There are mixed views on the property sector, where activity is almost at a standstill. Dunbar says property illustrates the great mismatch between the financial market and the real economy. He has lowered his property score from 4 to 3. However, Wyllie argues that, with interest rates at zero, property investment continues to provide “an attractive cash flow”.

We have redefined the commodities sector for the purposes of this survey to exclude gold and other precious metals, and focus on those most closely reflecting the global economy. Only Rob Burdett can see recovery in base metals and oil, so he has edged up his score to 7. Monique Wong takes the opposite view, fearing the continuing depressive effect of current “global demand destruction” on commodity prices.

Scorecard: panel tilts towards equities

Note: The scorecard is a snapshot of views for the second quarter of 2020. How the panellists’ views have changed since the fourth quarter of 2019: red circle = less positive, green circle = more positive. Key to scorecard: EM equities = emerging market equities. 1 = poor, 5 = neutral and 9 = excellent.

Corporate bond sector swings firmly into favour 

In this new period of weak equity markets and almost non-existent yields on government bonds, corporate bonds are seen as a higher-yielding diversifier down the risk scale from equities.

In the past, that role has often been taken by the property market. However, property markets have been badly affected by the lockdown, so the corporate bond alternative has come into play.

Panel members Rob Burdett and Monique Wong have joined Chris Wyllie and Richard Dunbar overweight in corporate bonds, making the sector one of the panel’s most favoured, alongside UK and Japanese equities.

“Corporate bonds fell out of bed during the crash,” says Wong. “But they are now being supported by decent yields and the prospect of support from some central bank purchasing programmes, alongside government bonds.”

Burdett has dramatically doubled his score from 4 to 8. “For the first time in 10 years, corporate bonds offer attractive yields at the investment-grade end of the market,” he says.

“Ultra-low rates became part of the whole credit crunch landscape after the financial crisis. But now corporate bonds offer the best risk/reward ratio out there. The risk of default is going to rise, but in an actively managed corporate bond fund, I think you can make some very good returns.”

Richard Dunbar agrees. “The yields of 3.5%-4.0% you can now get on investment-grade corporate bonds look attractive,” he says.

Only Keith Wade offers a dissenting voice. “In the current climate, I am worried about the impact defaults might have on the sector,” he says. He has halved his score from 6 to 3 as a consequence.

 Panellist profiles

Rob Burdett is co-head of multi-manager at BMO Global Asset Management and a research team leader. BMO has £187 billion in assets under management.

Chris Wyllie is chief investment officer at Connor Broadley, a financial planning and investment management firm with £400 million under management.

Richard Dunbar is deputy head of global strategy at Aberdeen Standard Investments, which has some £610 billion in client assets under management.

Keith Wade is the chief economist and strategist at Schroders. The asset management company has around £400 billion in assets under management.

Monique Wong is a multi-asset investment manager at Coutts, the private arm subsidiary of RBS bank, which has some £17 billion of assets under management.