When the COVID-19 crisis hit financial markets, we decided to hold more frequent Investment Committee meetings and provide you with regular updates on our thoughts and discussions from a portfolio perspective.

The following is a summary of the discussion and actions taken at our most recent meeting held on 7 April.

As you know, Lonsec’s Investment Committees are now meeting at least monthly, with additional meetings held as required. Our Investment Committees are comprised of our portfolio managers, heads of research, and external macro-economic experts. Our team utilises a combination of top-down and bottom-up analysis to establish our dynamic asset allocation positions.

Positioning leading into our Investment Committee meeting

Leading into the meeting our overall active asset allocation positioning had a defensive bias with a below-target allocation to developed market equities, a positive tilt to emerging markets equities, real assets and alternatives, and a largely neutral allocation to fixed income assets. We had held this positioning prior to the COVID-19 pandemic, which has served us well in limiting some of the downside associated with the market pull back, particularly in March.

Investment committee discussion

The key question we asked ourselves during the committee meeting was: when is the right time to take a more positive tilt towards risk assets given the material market pull-back we have experienced? When we assessed our Dynamic Asset Allocation (DAA) models, it was clear that valuations across most risk assets had improved materially over recent months. The biggest unknowN was to what extent the market had priced in the impact on company earnings.

In terms of policy, liquidity conditions improved over the month as central banks and governments reacted quickly via monetary and fiscal backstop initiatives. Most notable was the US Federal Reserve’s decision to extend their bond purchasing program to investment grade credit, which significantly improved liquidity conditions in global credit markets. From a cyclical perspective, our expectation is that economic news will be negative as it tends to be lagging in nature, and from an overall sentiment/risk perspective our indicators showed an improvement (decline in risk), although risk indicators such as the VIX remain at elevated levels.

While many uncertainties remain, our base case is that we may be in for a ‘U’-style recovery in markets, with the bottom of the ‘U’ potentially being elongated. However, if we take an 18-month to three-year view, and we are prepared to handle some volatility, a consideration to increasing our exposure to risk asset is warranted.

Asset allocation decision

The committee decided to increase our exposure to Australian and global equities from a slightly underweight exposure to a neutral position. The allocation was funded from our alternative exposure, which has played its role in the market pull-back as expected, providing some downside protection relative to equity markets. For our asset allocation without alternatives, the allocation was funded from excess cash positions in the portfolios. While we remain cautious on markets and expect volatility to continue, we believe that if we take a three-year view, risk asset prices will appreciate over this time.

What next

As part of our committee discussion we also flagged a review of our fixed interest exposure, particularly around the exposure to duration assets (government bonds) and credit. We have held a relatively neutral exposure to duration risk which has performed well relative to higher risk segments of the fixed income sector such as high-yield, emerging market debt and hybrids. We believe that central banks may continue to drive bond yields lower, however given the significant widening of credit spreads there may be an opportunity to increase the weighting to credit away from duration risk.

For more information on the Investment Committee work that we do for the Lonsec Model and Managed Portfolios, as well as other external consulting clients, please contact us on 1300 826 395 or info@lonsec.com.au.

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