Tuesday 7 April, 2020
Global Market View
Global equity markets fell dramatically in March as the true extent and financial impact of Covid19 became apparent. High volatility was the norm - with panic selling peaking mid-month, but risk markets bounced back strongly as devalued shares were bought up, and rescue / stimulus packages were announced. Interest rates are now very low with 10-year US government bonds at 0.65%, and the NZ dollar is now 0.5956 USD vs 0.6740 USD at the start of the year.A synchronised global recession seems certain, with the key question being how long, and deep, will it be? Central banks and governments are throwing the monetary (interest rates) and fiscal (spending/tax) book at the problem, combining huge rescue and spending packages with vast liquidity injections and promises of continuing support.
Through this turmoil, our portfolios have performed relatively well. Our global thematic strategy (our main active equity selection process) has done well. Currency hedging of 50% has taken the edge off market falls as the NZD fell. High quality fixed interest portfolios are preserving capital well, while alternative diversifying investments are significantly outperforming shares.
Tumultuous markets create opportunities for active management - and the portfolio management teams are hard at work identifying and positioning for these. While volatility is expected to continue, with the possibility of new lows in coming months, we expect that the recovery will be fast when it comes, with markets anticipating and moving well before the headlines. This crisis will pass - with building well diversified and quality portfolios designed to survive and thrive in the upturn, remaining our key focus.
Covid-19 special update - the market response
by Diana Gordon, Head of Fixed Interest
“And the rock cried out no hiding place”. I’ve worked through multiple turbulent markets from the Asian and Russian Crises of the 1990s through to the DotCom bubble, the Global Financial Crisis and the European Sovereign Crisis. The Global Financial Crisis was like a slow slip earthquake taking a bit over a year from the first inklings of problems to September 2008 when the Lehman collapse threatened to take down banks and insurance companies like dominoes. In many ways the Covid-19 crisis of March felt worse because of its speed. What had started as a Chinese supply chain story in February turned into a liquidity issue and then threatened a full-on credit crisis. Driven by Saudi-Russian tensions, the oil price declined 32% on March 9th helping to set off a chain reaction in the credit and stock markets which had already been buffeted by rapidly increasing alarm over Covid-19. When you get those types of moves there are a lot of margin calls on all sort of assets that people have borrowed against to fund their other investments. Pull on that string and just about any financial asset you could think of: gold, shares and yes, even government bonds sold off as people sold what they could for cash. Liquidity in bond markets ground to a halt.
However, despite the increasing toll of Covid-19, the markets ended the month in a better place following unprecedented co-ordinated government and central bank intervention.
- The US Federal Reserve announced a 100-basis point cut to its overnight interest rate on Sunday March 15th, setting the new benchmark rate at 0%-0.25% along with the start of a new round of quantitative easing (aka money printing). It first announced it would buy at least US$500 billion in Treasury securities and US$200 billion in mortgage-backed securities over “the coming months” to smooth the functioning of the Treasury and mortgage-backed securities markets. It also relaunched the Commercial Paper Funding Facility (CPFF) and the Primary Dealer Credit Facility, two crisis-era facilities for short-term loans and made US dollars available to other central banks, so they could lend to banks that need them. Later in the month the Fed responded to the growing crisis unleashing a shock-and-awe policy package. The Fed uncapped asset purchases, restarted yet another crisis-era tool, the term asset-backed securities loan facility (TALF), which makes loans to borrowers against eligible asset-backed securities (ABS) collateral. One of its more novel actions was the creation of the US$200 billion Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). The facilities are intended to purchase company bonds (or in some cases lend directly). This led to much tighter credit spreads and improved liquidity effectively serving to unfreeze US bond markets with a record amount of investment grade high quality company bond issuance. Having started the month at 1.16%, the interest rate on the 10-year US government bond finished the month at 0.70% down 46 basis points after having traded as high as 1.26% mid-month.
- The European Central Bank (ECB) launched a €750 billion Pandemic Emergency Purchase Programme which will buy public and private-sector securities until at least the end of 2020 to ensure liquidity in the market. There was even talk of “Coronabonds” being issued by the ECB – effectively covered by the full faith of the German Government - an idea that was not even entertained in the European Sovereign Crisis. The Bank of England (BOE) followed with two emergency interest rates cuts in a month, taking the benchmark rate to a record-low 0.1%. The BOE also announced a boost in its asset-purchase program target to £645 billion pounds made up mainly of gilts (UK government bonds). Finally, in Australia, the Reserve Bank of Australia (RBA) cut interest rates to a record low 0.25%. It also launched QE, saying it would do “whatever is necessary” to keep yields on three-year maturity government bonds at this rate and incentivised banks to continue lending to small businesses.
- In New Zealand the RBNZ’s playbook was no different to its global peers. It cut the Official Cash Rate (OCR) interest rate to 0.25% on March 16th and pledged to keep the OCR at this level for the next year. For the first time in its history, on March 27th it also announced a $30 billion Quantitative Easing directed solely to buy NZ Government Bonds. This helped calm the NZ Government Bond market somewhat, after a vicious sell off following the announcement of a $12.1 Billion dollar government stimulus government package. However, other high-grade issuers, like The Local Government Funding Authority (LGFA) (rated AA+) and Housing New Zealand (AA+) remained dislocated with very poor liquidity (the Deputy Reserve Bank Governor recently has intimated that they will be included in the program in the near future). Ahead of QE, the RBNZ moved to ensure liquidity in the banking system via its Term Auction Facility helping with liquidity. Separately the government also stepped in to support Air New Zealand with a $900m convertible loan and the Treasury announced a $12.1 bn support package (subsequently expanded) to combat the impact of Covid-19. The yield on a 10-year NZ government bond went up by 5bps in the month to 1.22% after trading as high as 1.95% mid-month.
All these interventions were required due to the dour outlook for the global economy. No one is quite sure where unemployment will go to but in the short term most developed countries - including our own - may effectively see that rise through 10%. The economic activity hit will be equally as shocking most likely followed by a bounce but probably not that straight up-and-down V shape that the optimists were projecting even as late as February. Clearly much depends on how fast economies get back to the new normal as we wait for a vaccine. There are strong signs that the Chinese economy is getting back online and that bodes well for our agricultural industry not least with an NZ$ that is currently sub US60c. But on the other hand, tourism-related industries will be extremely hard hit. That leaves the government to act as a shock absorber, supporting workers through the quarantine and beyond. Luckily, we did start the crisis with an excellent government balance sheet (19.5% net debt:GDP). While this figure may go as high as 40-50%, that would still leave us as a nation in pretty good financial shape. Looking at the projections from epidemiologists, we do believe that the now almost globally concerted approach to breaking the chain of infection should pay dividends even as April will be unspeakably painful for many around the globe. There are currently signs are that New Zealanders will be spared some of this terrible loss and we will come out of this - but clearly there is a tough 18 months ahead of us.
by Steffan Berridge, Senior Quantitative Strategist & Nathan Field, Portfolio Manager - Global Thematic
The Global Quantitative fund returned -8.82% in March, 62bps ahead of the MSCI AC benchmark in NZD terms as COVID-19 spread globally and was declared a pandemic by the World Health Organisation. The impact on markets was severe as many regions imposed stay-at-home orders and social distancing guidelines, forcing some parts of the economy to a standstill.
Our best sectors for the month were Financials and Technology with our underweight to Banks and overweight to Technology across the board aligning with the relative performance of those sectors. Cisco and ASML led gains in Technology, while game developer Take Two Interactive, now part of the Communications Services sector, was the best overall position. Our worst sector was Energy where, despite our underweight, the names we held proved vulnerable to the weak demand picture.
The Global Thematic fund was able to avoid the worst of the market sell-off with a -4.6% return in NZD, outperforming the benchmark by 480 basis points. Key to the portfolio’s resilience during the coronavirus-led plunge has been our investments in all-weather themes such as US electricity utilities (NextEra Energy, Dominion Energy), multinational food companies (Nestle, Pepsi) and companies that benefited from restocked pantries (Costco, Colgate Palmolive, Procter & Gamble).
Global Quant’s top-down macro positioning now favours Europe, and we continue to focus on those companies with attractive metrics across earnings quality, capital efficiency, valuations, sentiment and sustainability. Over the month, we’ve increased our allocation to Financials (Royal Bank of Canada, Ping An) while further trimming Energy (Devon, Canadian Natural Resources). Healthcare and Technology are our favoured sectors, while Energy and Materials remain out of favour.
Global Thematic have maintained their defensive positions in the portfolio, but the market carnage also presented a number of buying opportunities in high growth stocks that had come back down to earth. For example, Tesla fits neatly into our Electrification theme, and CrowdStrike is a leader in the growing demand for cloud-based security. We think this balance between defensive and secular growth stocks is the right approach given the many uncertainties facing the global economy.
Here’s an update from our Global Thematic Portfolio Manager - Nathan Field on the team’s current response.
by Diana Gordon, Head of Fixed Interest
The Kiwi Wealth Fixed Interest Fund (Fixed Interest Fund) returned -0.91% after fees and taxes in March underperforming its benchmark which returned -0.1%. This was almost wholly due to credit spread widening in a company bond market whose rapid decline eclipsed that of the Global Financial Crisis. Credit spreads are the extra yield you receive for owning a bond issued by a non-government entity like a company or a quasi-government entity like the Local Government Funding Agency that funds our local councils. When credit spreads increase, all things being equal, the price of a bond goes down. Conservative positioning allowed us to stay close to the Fixed Interest Fund’s “risk-free” yardstick of the S&P/NZX NZ Government Bond Index and I thank my team for their enormous effort over March where we spent the entire month with one sole intention: protecting your capital.
If you’ve read many of our fixed interest monthlies, you’ll know that we have been increasingly leery of credit markets with the belief that we are far into the economic cycle and that low spreads were not compensating for the risks. Those main risks are i) credit risk, the risk that an issuer may not pay you back and ii) liquidity risk, the risk that a bond cannot be sold fast enough without impacting the market (we’ve noted that banks that buy and sell government and company bonds have increasingly walked away from supporting bond markets). Our conservative stance (average credit rating AA) has proven correct albeit few could have guessed that Covid-19 would be the catalyst for such a sell-off in company bonds. After seeking the safe haven of US Treasury (AA+) bonds as a rainy day fund as the crisis deepened, we were largely a seller of these in March, preferring to hold overnight cash (Westpac (AA-)). Similarly, we sold short maturity Rentenbank (AAA) and Transpower (AA-) bonds.
We do own a few names in small size like betting firm William Hill (BB+) and Hilton Hotels (BB+) that have been hit by quarantines, but which are excellent franchises. Likewise, we also own a number of high-quality Oil & Gas and energy infrastructure companies like BP Plc (A-) and Chevron (AA-) and Williams Companies (BBB) whose bonds declined due to the oil price collapse. We sold down some of our retail finance company Ally (BBB-) position on concerns over the US retail customer in the wake of a relatively poorly handled US government response to the virus. Although the bonds of New Zealand airport companies have not declined in price significantly and have become fairly illiquid, we are looking for clarity from the government for their support (which we expect). We own a couple percent in total of the fund in Christchurch (BBB+), Wellington (BBB+) and Auckland Airport bonds (A-) which we view as having strong asset value, but which obviously face a pretty challenging next 18 months. (Indeed, as we write this, Auckland Airport has announced a $1.2bn share offer).
In times like these, return of rather return on capital is our watchword - and that’s not likely to change for a while. On that note, we started to add some New Zealand Government Bonds (AA+) and expect to buy more in April. At some point, we will turn to looking to add high quality company bonds but for now we are planning for that and not stretching.