Thursday 28 January, 2021
2020 Year in Review
As the world celebrated New Year’s Eve in 2019, no one could have foreseen one of the most turbulent years in modern history. The rollercoaster of 2020 has had an extraordinary impact not only on the economy and financial markets, but on all our personal lives - with a monumental transformation in everyday interaction across a wide range of contexts.
Covid-19 hit hard and fast like no other. Within weeks, the novel coronavirus had spread across almost every inch of the world. Travel became non-existent as cities went into lockdown. Entire industries were negatively affected and millions of jobs lost. The S&P 500 lost more than one third of its value in under a month, breaking the record for the fastest ever decline of that magnitude - and oil prices went negative for the first time in history.
The bear market didn’t last long however, thanks to governments around the world pumping trillions of dollars’ worth of stimulus into the global economy, and interest rates collapsing to record lows. Quantitative easing helped keep financial markets functional, with just about every tool of Central Bank arsenals being mobilised.
Despite all the doom and gloom, global stock markets finished the year at new record highs, as investors looked beyond Covid-19 to vaccine developments, the US election, Brexit and the likelihood of long-term growth.
While 2019 markets were heavily implacted by trade wars, the preeminence of big tech and a slowly imploding oil sector, 2020 opened with a completely new crisis from left field which dominated market dynamics for the year and is likely to keep doing so in 2021.
In the first part of 2020, Covid-19 put the brake on travel and leisure, accelerating trends like the dominance of Technology companies who could now provide much-needed work-from-home tools in addition to other in-demand product lines, and online retailers who saw a pickup in already strong demand for their channels. On the other hand, extreme weakness came from Energy companies with demand for oil plummeting, Financials coping with yet another round of record low interest rates, and bricks and mortar retail.
Healthcare, which at first appeared to be in a good position to weather the crisis, soon split between those positioned to supply protective gear and develop vaccines performed strongly versus those who had to put activities like elective surgery on hold.
The second part of the year offered isolated reprieve as new vaccine trials proved wildly successful and offered a light at the end of the tunnel. Energy remained the weakest sector, however the November Pfizer/BioNTech announcement saw the Energy sector 12% higher in a day and triggered the biggest
one-day junk rally ever seen, offering a lifeline not only to vulnerable individuals but also down-and-out sectors around the globe.
Finally, 2020 saw very strong growth in sustainable investments with the pandemic providing a tailwind both for demand and performance in so-called ESG investments, those offering stronger outcomes in Environment, Social and Governance arenas.
Unsurprisingly, Covid-19 dominated fixed income markets in 2020. February and March saw central banks cut interest rates aggressively around the world, with long term interest rates falling to multi-generational lows as equity markets cratered and oil prices crashed. The global financial crisis handbook was well and truly cracked open with central banks buying back bonds, providing liquidity to banks, and facilitating loans to small business-es among many other supports.
And not a moment too soon. Even US government bonds, one of the most liquid bonds in the world proved hard to trade at the worst part of the risk sell-off in March, until the central bank cavalry came over the hill. Governments’ responses such as wage subsidies and outright stimulus cheques were no less extraordinary.
A combination of central bank and government interventions firmly reduced the risk of a depression and fuelled a massive asset-price rally from gold to stocks to commodities. An interest rate bounce during our winter was augmented by positive vaccine announcements in October and the outcome of the US election in November which cemented the likelihood of further stimulus. In the days post-election, few pundits believed both Georgia seats would go Democrat with the prospect of even more stimulus, but as the year ended, global rates began to creep up as that eventuality became more likely.
While New Zealand was thankfully able to chart its own course through the pandemic, we generally followed global patterns in interest rates in all but one dimension. After cutting the OCR (Official Cash Rate) from 1% to 0.25% in March, the Reserve Bank was adamant through November that negative OCR rates were on the table after February 2021. Despite the crisis hitting harder overseas, other central banks were clear that negative interest rates were decidedly off the table, citing research that it was potentially ineffective. The RBNZ’s stance changed abruptly post the positive vaccine news along with further evidence of economic strength and burgeoning house price inflation driven by lower mortgage rates.
Consequently, we ended the year with all cuts to negative interest rates priced out of the market. The interest rate on a 10-year NZ government bond started the year at 1.74% and fell to a low of 0.46% after the announcement of our own aggressive government bond buying program. It ended the year at 0.99%.
The Kiwi Wealth Growth Fund (Growth PIE) performed exceptionally well in 2020, returning 11.86% for the year after tax and fees , beating the benchmark by 3.49%. The main underlying strategy components of the fund include: Global Thematic, Global Quantitative, Core Global as well as alternative investments.
Global Thematic locked in yet another strong year returning 16.02% in gross NZD terms, beating the MSCI All Country benchmark by 6.56%. Many of the stay-at-home themes benefitted the portfolio through the Covid crisis and helped cushion downside through the height of the turmoil. Global Quantitative also returned a re-spectable 9.71% gross, beating its benchmark as well as comparable strategies in the market.
Core Global also enjoyed a year of outperformance with respect to it’s benchmark, and continues to target a tracking error of less than 1%. Lastly, the alternative investments performed well particularly during the selloffs early in the year which helped to mitigate tail risk. As equity markets bounced back, some of those gains were given back but overall the alternative assets finished the year up 8.69% gross.
Fixed Interest Fund:
2020 was another pleasing year for the Kiwi Wealth Fixed Interest Fund (Fixed Interest PIE) which returned 4.04% after taxes and fees , outperforming the benchmark by 0.52%.
We began to add longer maturity US Treasuries in January through March as news of the pandemic started to concern us. We emphasised investing in very high-quality longer maturity NZ bonds on the announcement of the LSAP in March but began to reduce both exposure to New Zealand (favouring harder hit Australia) and overall maturities as the year ended. This was in the wake of the Reserve Bank’s stepping back into line with global peers and the positive vaccine news. Exposure to corporate bonds hit us in March but they performed well over the year as credit spreads tightened into year end.
 Investors pay tax in the funds at their marginal rate but for the purposes of this calculation we assume the top rate applica-ble which is 28%. A fee of 1.5% for the Kiwi Wealth Growth Fund (Growth Fund) and 0.5% for the Kiwi Wealth Fixed Interest Fund (Fixed Interest Fund) is assumed. These are the same fees used in the respective benchmarks. We use the Growth Fund and Fixed Interest Fund as proxies for performance of client portfolios. This is because these funds are fully tax paid and reflect the most accurate performance of client portfolios.
Private Portfolio Client Returns
We have used the returns from the Fixed Interest Fund and the Growth Fund as the basis for calculating
a proxy for client portfolio returns in broad mandate groupings:
An ‘Income’ portfolio is calculated as a simple weight of 75% Fixed Interest Fund and 25% Growth Fund;
A ‘Balanced’ portfolio is calculated as a simple weight of 50% Fixed Interest Fund and 50% Growth Fund; and
A ‘Growth’ portfolio is calculated as a simple weight of 25% Fixed Interest Fund and 75% Growth Fund
|2020 Performance Summary|
Kiwi Wealth portfolio return
out-performance over benchmark
|Average weight in Growth PIE Fund||Average weight in Fixed Income PIE Fund|
After 2020, no one can be blamed for feeling more optimistic about the year ahead. However, 2021 got off to an inauspicious start with the political turbulence surrounding Joe Biden’s certification as the President-elect - with the US Capitol riot leading to Trump’s second impeachment.
However, markets continued to shrug off the disturbance from the insurrection as it was still digesting the implications of the Georgia Senate races - which switched the balance of power (narrowly) to the Democrats. Any market concerns about the possibility of rising taxes and increased regulations were outweighed by optimism surrounding increased stimulus measures - and while Democrats now control the Government, a tight balance in the Senate should limit opportunity for the party’s more aggressive agenda items from coming to fruition; an outcome most participants see as a positive in market terms.
On the global economic front, we expect much of the pace of recovery to be driven by the success of vaccine distributions. While it is probably true that a lot of optimism is already priced into the market on a vaccine-related economic recovery, we also believe that markets will most likely look past short-term distribution disruptions. A Brexit deal has helped clear up the political and economic picture in Europe, but the threat of the new Covid-19 strain remains.
The combination of easy monetary policy and increased stimulus should continue to support equities in 2021, with a relaxation of border restrictions and social distancing likely to benefit sectors such as travel and hospitality, and increased infrastructure spending supporting Industrial and Materials sectors. The Energy sector is also likely to see a reprieve in the short term as demand for oil rebounds, however with that industry falling into obsolescence it’s hard to get too excited about investing. Big tech on the other hand is expected to face continued headwinds as growth opportunities decline and regulators focus on the more troubling aspects of their businesses.
As the US political outlook becomes more clear and vaccine distribution begins in full, we believe corporations will be more comfortable releasing some of the large amounts of excess cash on their balance sheets to ramp up capital investments, participate in M&A, reduce debt and increase capital return. A topic of fevered debate is the valuation of equity markets, which are expensive by historical standards and some commentators see the current level as unsustainable. The big difference between the current market and previous periods of exuberance such as the Tech boom is that interest rates are currently at record lows, meaning equities are attractive compared with government bonds so long as yields stay around where they are.
The global bounce back is expected to provide upwards pressure on yields as flight-to-quality trades unwind and inflation rises. However, we expect almost all central banks to allow inflation to “run hot” in excess of 2% prior to them even signalling that they will be raising their overnight rates - which is more likely to be a 2022 story. In addition, central banks as-a-whole (including New Zealand) remain committed to suppressing longer term interest rates via bond-buying programs. Clearly that view would change if inflation pushes up more aggressively. Our base case is that the economic damage from COVID-19 will take some time to repair with periods of fluctuating but not overaggressive inflation.
Domestically, the economy has recovered faster than most pundits anticipated, although a more comprehensive picture of the impact of border closures won’t be understood until after the height of the tourist season is over. The timing and efficacy of the vaccine distribution will of course determine border conditions, but we expect expansionary fiscal and monetary policies will continue to support solid domestic demand - and strong housing price growth to boost the wealth effect on consumption for NZ homeowners.