Lonsec Market & Portfolio Update: 17 March

Lonsec Market & Portfolio Update: 13 March

The COVID-19 virus has triggered a significant sell-off in markets and a spike in volatility. The VIX Index, which is a measure of forward-looking volatility for the S&P 500 Index, moved from around the 14% mark in mid-February to over 54% on 9 March, its highest point since the global financial crisis where the VIX reached above 70%. At the same time the oil price, as measured by the WTI Crude, started 2020 above the $63US mark has fallen below $40US per barrel on the back of an oil price war between Saudi Arabia and Russia.

Leading into the current market conditions, asset prices were viewed by Lonsec as trading at fair to expensive territory. The low interest rate environment continued to support risk assets and there were signs that some of the economic indicators that were trending down, such as global the PMI, stabilised and lowered the risk of a global recession. Roll forward to the current situation and asset class valuations have pulled back although they are not in ‘cheap’ territory. There is an expectation that economic indicators, many of which are lagging, are expected to be adversely impacted by the effect of the Covid-19 virus and market momentum has turned negative. From a policy perspective we have seen rate cuts in the US and the announcement of fiscal stimulus packages by governments around the globe, however the extent of any future stimulus is uncertain. What is also unclear is the length of time the virus will last, with the view being that the longer it lasts the greater the chance of a recession.

From a Lonsec perspective, based on the information we currently have, we think that growth is likely to slow and a mid-level recession is possible should the length of the virus extend into the months ahead and fiscal stimulus is insufficient to alleviate any downturn, Unlike 2008 the banking sector remains intact however any downturn will likely be driven by supply and demand side pressures.

Our overall asset allocation positioning retains a slight defensive bias. We believe that at some stage there will be an opportunity to take a more positive tilt into growth assets however in a period of uncertainty our focus is on further diversifying our portfolios with assets and investment strategies that offer diversification.

How are we positioning our portfolios?

  • The Lonsec Multi-Asset and Listed Managed Portfolios were cautiously positioned leading into the new year.  From a Dynamic Asset Allocation (DAA) perspective, we were slightly underweight both Australian and global equities in favour of real assets and alternatives (within the Multi-asset portfolios). The Retirement Managed Portfolios have also been positioned with some more defensive strategies incorporated within the portfolio to provide cushioning in a market downturn.While we had no way of predicting the emergence or extent of the Coronavirus, we viewed equity valuations as being stretched and therefore vulnerable to any potential shocks to, what we saw as, an overly optimistic growth outlook.  The speed and severity at which equity markets have responded to the outbreak over the last few weeks has surprised many, including ourselves. In a typical ‘flight to quality’ episode, traditional defensive assets such as government bonds performed well, offsetting some of the losses inflicted by the aggressive sell-off in risk assets such as equities and high yield bonds.
  • Against this backdrop, the Lonsec Multi-Asset portfolios outperformed their respective benchmarks over the month of February (with the exception of the Conservative portfolio which was marginally under its benchmark for the month).  The Listed portfolios tracked the markets given the higher exposure to market beta, given the portfolio invest solely in listed investments including passive ETFs.
  • Our Australian equity managers performed well, notably those with a strong risk management focus. AB Managed Volatility Equities Fund and Pengana Australian Equities Fund both significantly outperformed the benchmark.  Allan Gray Australia Equity Fund was however a clear underperformer, with its deep value contrarian investment style struggling in this environment.  Global equity managers performed largely as expected, with Antipodes Global Fund providing good risk control by design. Our unhedged global equity exposures also benefited the portfolios with the falling AUD cushioning the extent of losses within our global equity portfolio.  Overall our equity managers have adopted a more defensive positioning in recent weeks. Where they have the flexibility, they have been increasing their cash holdings and reducing exposures to sectors impacted most heavily by the Coronavirus.
  • Our preference for ‘defensive’ fixed income assets has also benefited the portfolio with government bonds and high-quality corporates outperforming high yield credit. Our fixed managers have been adding duration in recent months which has provided good risk-off diversification benefits at the portfolio level.   Our alternatives managers produced mixed results. CFM Institutional Systematic Diversified Trust was a clear detractor from performance, with all underlying sub-strategies unexpectedly delivering losses in February.
  • Looking forward, we have maintained our defensive positioning and are looking to further diversify the portfolios at higher risk profiles. We remain slightly underweight both Australian and global equities in favour of real assets and alternatives.  We favour Global REITS and Global Listed Infrastructure where we see better value and believe they will continue to be beneficiaries of a low interest rate environment. Within global equities we maintain a preference for emerging markets over developed market on the basis that emerging market central banks and governments have far greater capacity to respond to any extended downturn through both monetary and fiscal policy.  Developed market central banks on the other hand, are low on firepower meaning governments will be left to pick up the slack with more co-ordinated fiscal spending.
  • While we have little clarity on how long the impact of the Coronavirus outbreak will last, we do expect volatility to continue and seek to manage risk through the multiple levers available to us; active asset allocation, lowly correlated return sources (including alternatives and traditional diversifiers such as government bonds) and by investing in high-quality managers. We expect central bank and fiscal support to be forthcoming which should provide much needed support for global economies and help steady markets.  That said, the outlook remains uncertain.  Our portfolios remain very liquid which puts us in good position to take advantage of opportunities should conditions improve.

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