First the Fall. Now the Recovery?
After a tumultuous start to the year, investors could be forgiven for wondering which way to turn in a Covid-19 world. Here, managers from BNY Mellon Investment Management offer their roadmap for a possible route out of the crisis.
At some points in March it might have felt like investors had nowhere to hide. First, equities began to tumble, then the contagion spread to fixed income, initially affecting high yield credits before moving along the risk curve so even investment grade and seemingly solid sovereign bonds began to falter. Soon, commodities felt the chill wind of the selloff with oil prices taking a historic tumble. Eventually even gold–considered by many to be the ultimate “safe haven” asset – lost its way amid the pandemic-fuelled dash for cash.
Little wonder, then, if at times investors felt more than a little bit rudderless. After all, where could you turn if even the safest of safe bets lacked immunity to the Covid-19 contagion?
Now, as volatility recedes and the dust begins to settle on a generation-defining market event, it may be time to consider the path ahead. How should investors respond to current market conditions? Should they go defensive – perhaps repatriating from emerging markets in favour of a more domestic focus? Is hoarding cash the way to go or should they take a trip up the risk spectrum in the hope of recovering some of the ground lost in the first quarter? What will the next few months bring and how should investors respond?
For Paul Brain, head of fixed income at investment investment manager Newton, one of the likely legacies of the Covid-19 crisis is a lasting change to behaviour by companies and investors, which will have a profound impact on bond and equity markets in the months and years to come.
Many companies, he notes, have already switched from a focus on maximising shareholder value through share buybacks and dividends to one that is more focussed on keeping their businesses alive as they face significant drops in cash-flow.
“For investors, the collapse in dividend pay-outs could re-focus their attention on bond income which is contractual and therefore more stable,” he says. “The economic uncertainty has raised the potential for bond downgrades and defaults but substantially raised the yield available on a broad universe of corporate bonds, thereby improving the income stream in the future.”
One other element of behavioural change, according to Brain, is the potential for companies and investors to have a higher level of savings to address uncertainty around the future course of the pandemic.
Meanwhile, central banks have given strong signals through interest rate cuts and quantitative easing programmes that they will support any additional supply of government bonds and offset any supply-induced yield increases. “In many countries this support has also been given to investment grade corporate bonds to allow many larger companies to access funding to support themselves through the crisis,” adds Brain. “This gives extra confidence to investors that they are less likely to experience losses from investing in bonds.”
The stockpicker’s view
For George Saffaye, manager of the BNY Mellon Mobility Innovation strategy, the past few months have been a story of equity investors reacting to (and sometimes overreacting to) the latest headlines.
“They’ve been at home, hunkered down and constantly exposed to increasing uncertainty through the media,” he says, noting that this kind of attention to the latest newsflow cuts both ways, with good news as well as bad directly affecting behaviour. “You see this in how the market recently reacted to data from a promising drug, which could potentially be used as a treatment for Covid-19 symptoms,” he says. “The market is directly attuned to that.”
But now, as the worst of the volatility begins to recede, Saffaye believes investors are slowly beginning to gain in confidence. “I think the initial data – on highly-infected areas displaying slowdowns in new cases, for instance – as well as some US states starting to open up, is helping to mitigate some of that uncertainty,” he says. “This resilience comes after one of sharpest declines in bear market history, exacerbated by the uncertainty of an unforeseen public health crisis.”
The contrast here, says Saffaye is with the Global Financial Crisis (GFC) of 2007/8. “That was a systemic issue and this is more of a transitory issue,” he says. “Think about the Great Depression in the 1930s; that affected everybody. While this affects everybody too – a lot of people feel this will pass. They believe the financial system was in good shape prior to this and we just have to get through it. I think investors are keeping the transitory nature in mind. Look at the rebound in markets. Even as equities go down, there’s a pop back when optimism comes in. That’s an example of the resilience in markets.”
For the future, Saffaye wonders whether millennial investors in particular, who have already experienced two generation-defining market selloffs, might not consider diversifying away from equities in favour of hard assets, perhaps even putting more of their investible dollars towards home ownership.
Even so, he says, the virtues of active management are likely to become even more apparent in the current market. “This is an opportunity for active managers to really lead the way,” he explains. “Passive management has its place but if you’re buying the whole index, you’re getting everything and lose the ability to be selective about what you own.”
Towards a more caring style of investing?
But perhaps more profound changes are afoot. One inescapable facet of the current crisis is how deeply each of us has been affected by the lockdown measures put in place to prevent the spread of Covid-19.
For Andrew Parry, Newton’s head of sustainable investment, those of us fortunate enough to be able to continue their jobs by working from home have played a part in a fascinating experiment in alternative working arrangements, with technology enabling something resembling ‘business-as-usual’ even in the most trying of circumstances.
“What this has shown is that flexible arrangements are achievable and can play a part in providing a good work-life balance for many,” he says. “Reflecting on the lessons learned, companies will recognise that more flexible working patterns are a great way to retain and motivate people.”
Companies that take this message to heart could experience greater job satisfaction from their workforce along with other benefits such as lower space requirements and lower staff turnover. “Meanwhile, savings from reduced business travel could focus the mind not only on the bottom-line benefits, but also the lower carbon footprint of businesses,” adds Parry.
But a wider change could also be in the making, as Parry believes, the Covid-19 crisis has helped usher in a different understanding of what companies actually stand for. “First and foremost this is a human crisis and, understandably, people have paid close attention to how companies have responded,” he says. “The majority have responded with a high level of empathy and compassion; and those that haven’t have been on the receiving end of public opprobrium through the press and social media, potentially permanently impairing their reputation. Perhaps the time has come to recognise that the age of the primacy of the shareholder that Milton Friedman ushered in almost 50-years ago is now well past its sell-by date.”
In the long term this could mean a sea-change in how investors view their holdings. Concludes Parry: “The economic shock has exposed those firms that have traded resiliency for efficiency, normally through the use of financial engineering to support short-term profitability. Instead of arguing why environmental, social and governance considerations should be used when investing, it’s now the case of asking why wouldn’t you think about these issues? Not to seriously integrate ESG into the analysis of a company is to have an incomplete picture of the opportunities and risks for the enterprise.”