Your investment update Q2 2020
This document has been produced by Seven Investment Management LLP from internal and external data. Any reference to specific instruments within this document are part of widely diversified portfolios and do not constitute an investment recommendation. You should not rely on it as investment advice or act upon it and should address any questions to your financial adviser. The value of investments can vary and you may get back less than you invested.
Your Investment Update –  Q2 2020
Contents 04
Welcome
Martyn Surguy Chief Investment Officer 08
Strategy Lockdown and after Terence Moll Head of Investment Strategy
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Portfolio implementation What we are doing in portfolios Haig Bathgate Head of Portfolio Management
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Featured topic Don't let the lizard loose! Ben Kumar Senior Investment Strategist
Visit us at www.7im.co.uk to find out more about our latest news and views.
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Your Investment Update – Q2 2020
Welcome MARTYN SURGUY Chief Investment Officer
Little did I imagine in January that the next time I penned this introduction we would all be sitting at home with the economic, political, investment and social landscapes fundamentally changed. Words like “unprecedented”, “uncharted” and “extraordinary” have become staples for investment managers. The priority at this time, of course, is to ensure that everybody is safe and well. It’s difficult not to be affected by the scale of the challenge facing our health workers and the sacrifice they are making on our behalf. For us at 7IM, the challenge is to ensure that our clients’ assets are looked after in a safe environment with full oversight and effective, timely decisions being taken. I am pleased to report that this is absolutely the case and the firm’s continuity planning moved smoothly into action in mid-March. Although we are all working from home the processes underpinning the management of our clients’ money are functioning smoothly. Each day begins and ends with a team meeting to discuss the issues of
the day (video late afternoon and phone in the early morning so we don’t alarm one another). The Strategy Team speaks daily as markets are moving quickly and we want to be sure that opportunities are identified early. The Portfolio Management and Selection Team meets weekly to review the positioning, views and performance of our managers. I chair a twice-weekly Investment Committee to ensure that all decisions are considered and approved correctly. As an investment firm we are as much risk managers as portfolio managers, and thorough risk management is embedded into our investment process. During these turbulent times our dedicated Risk Team is working closely with us to ensure that liquidity, counterparty and
Your Investment Update – Q2 2020
Thorough risk management is embedded into our investment process.” market risks are managed appropriately. Although we absolutely would not recommend dashing for the exits at this time, their work ensures that our clients can have their money back whenever they want it. »
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Your Investment Update – Q2 2020
Welcome Continued
In terms of investment markets over the short term, I have to invoke John Maynard Keynes to say “we simply don’t know”. However, what we do know is that as investors rather than speculators or traders, we have to keep long term goals and objectives firmly in mind. Each of our portfolios has a strategic framework to provide a sensible spread of assets to do exactly that. It’s encouraging that in similar episodes like the financial crisis ten years ago this framework navigated and emerged from the crisis largely unscathed. We are confident that it will also come through this time, albeit with downdrafts along the way. In the last few weeks, markets have been as wild as in the financial crisis of 2008, or the Asian crisis of 1998. Our Head of Investment Strategy, Terence Moll, has the unenviable task of making sense of them overleaf. He begins, inevitably, with the coronavirus, then looks at
how we expect the world will bring it under control and how economies will gradually recover. Upheavals in financial markets always produce areas of dislocation and opportunity. We are alert to this and are starting to see a number of them appear, particularly in fixed income. This sort of tactical tilt to our long term positioning can be an additional source of returns in the long run. Our Head of Portfolio Management, Haig Bathgate, discusses what we’ve been doing in portfolios recently. One of the keys to managing money in times of great uncertainty is to keep our emotions in check. Emotional responses are often wrong at such times – a desire to sell everything and run for the hills is not rewarding for long term investors. Our behavioural expert and Senior Investment Strategist Ben Kumar addresses this in his article.
Your Investment Update – Q2 2020
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In conclusion, I would like to stress that as a business we are functioning as normal. Current conditions are beyond unsettling, but they too will pass. It is easy to fall into an overly negative mindset at such times. We are keen to avoid this, as it prevents opportunities being seized. We are prepared for what markets might throw at us and retain a strong conviction in the investment beliefs that have served us well through time. Please take care, stay safe and look after your family and friends. We look forward to better times ahead.
We are prepared for what markets might throw at us and retain a strong conviction in the investment beliefs that have served us well through time.
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Your Investment Update – Q2 2020
Strategy Lockdown and after You don’t expect to see a fox loping along Threadneedle Street at 9am on a Friday morning. But there it was, not far from the Bank of England, looking as though it didn’t have a care in the world. It probably didn’t. As I jogged through the City following my exercise routine two weeks after lockdown, the only moving vehicle in sight was a scooter, ridden by a young guy with a bandanna and mask. The coronavirus has changed how the world works. Sooner or later we’ll get the horror under control, but some aspects of our lives will never be the same again. Lockdown and after About half of the world’s population is in lockdown. Keeping away from other people, staying at home, phoning elderly relatives often and washing our hands. During lockdown, the idea is to crack down on the virus and stop it from spreading. If the restrictions are tough and enough people follow them, then case numbers should level out and fall eventually.
It’s reassuring that the coronavirus looks under control in countries that acted early and aggressively, like South Korea and New Zealand. Even in Italy and Spain, new case numbers are drifting down. The UK should follow soon. There is hope. We expect that some of the lockdown regulations will be eased over the next few weeks. People will gradually go back to work, shops will reopen, followed by schools and universities in due course. That’s already happening in the parts of China, as well as some European countries, that were worst hit by the virus. Life will slowly resume. But social distancing will stay in place for the time being. There’ll be no theatre or live football for quite a while. People will be tested for coronavirus on a large scale, and quarantining will become the norm. If the virus pops up again then the rules will be tightened. Up down, up down. We’ll see a balance of measures to get our lives and the economy back on track, while keeping the virus subdued.
Your Investment Update – Q2 2020
The next few months will be hard. They’ll be toughest, of course, for people who are sick, especially if they’re older and vulnerable. Also hard for NHS workers, for elderly people, for parents with young children, and many others. The good news, though, is that the heavier the lockdown, the sooner the virus retreats. We could be talking a few weeks rather than months. Back to work The economic costs of lockdown are huge. Firms close their doors and some won’t open again, people lose their jobs and incomes, kids miss out on large chunks of school. Most likely, the world has already entered its sharpest recession ever. Some economies are expected to contract by up to one quarter in the next couple of months. The economic numbers ahead will be ghastly – the worst since the 1940s – but we expect the downturn to be short-lived. It will probably be followed by a steady recovery. »
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Even in Italy and Spain, new case numbers are drifting down. The UK should follow soon. There is hope.”
TERENCE MOLL
Head of Investment Strategy
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Your Investment Update – Q2 2020
Strategy Continued
A big reason for this is that governments everywhere have realised that households and firms need support while we’re all waiting for the virus to burn itself out. In the UK, most newlyunemployed people qualify for government payouts of 80% of their previous incomes while they wait at home. Firms are being helped too. When the lockdown is eased, people will get back to work and begin spending, and firms will ramp up their output fast. In the UK and US, the looming fiscal assistance is estimated at 10-15% of GDP. If that’s not enough, governments will spend even more. They will do whatever it takes to keep their economies from imploding. We are all Keynesians now. Nonetheless, the recovery won’t be immediate. Many people will save more, just in case, tourism and business travel will be depressed, ongoing health regulations will be a hassle, shopping centres will be half-empty.
It could take a couple of years before unemployment is properly down again and the economy feels strong. We are optimists. Humanity will win the war against coronavirus. This could be via cocktails of drugs to help people cope with and recover from COVID-19. Several are being tested already and look promising. They might materialise on a large scale later this year. Or we might get a vaccine. Some experts think one might be finalised by next year. At last count, about 50 vaccines were being developed across the world. Hopefully, one of them will be a winner. Science, human ingenuity and big budgets can do great things… look at the US Space Program in the 1960s! But let’s be realistic. These solutions are at least six to twelve months away.
How to invest We’re in a period that looks more uncertain than any since the global financial crisis of 2008. How should investors manage their portfolios through the next two years? First, it makes sense to diversify as much as possible. We’ve been beating this drum for ages, and it’s especially true right now. When the world looks wild and scary, aim to hold a little bit of everything. Second, keep an eye out for those bargains that often appear after violent market sell-offs. For example, we like European dividends, which can be traded as a stand-alone investment, separate from the share prices of the companies that pay them. The market is valuing 2023 dividends two fifths lower than three months ago. While many large European companies are struggling, we think most of them will come through. Their future dividends look cheap.
Your Investment Update – Q2 2020
Third, beware of cash. Investors who panic and sell equities might feel good that they’re out of the market. But cash is a loser in the long run, and it’s amazingly hard to time when to buy equities again, as described in Ben’s piece on lizard investing. It’s often better to hold a range of assets for the long run, while accepting that they will go up and down along the way.
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We are optimists. Humanity will win the war against coronavirus.”
Science, human ingenuity and big budgets can do great things‌ look at the US Space Program in the 1960s!� Terence Moll, Head of Investment Strategy
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Your Investment Update – Q2 2020
Portfolio implementation What we are doing in portfolios As Terence said, at 7IM we’ve been beating the drum about diversification for many years. It’s been central to our investment process since the company was founded in 2002. Diversification means that you hold a range of assets with different drivers, so when one part of the portfolio falls, other parts could potentially pick it up. We have always believed in having a higher allocation to alternatives than most of our peers and as you would expect, our alternatives allocation is also diversified. It includes assets where we believe long term returns are likely to be strong, as well as assets that are focused on protecting the portfolio if markets crash. More than any other asset class, alternatives need care and attention. You really need to know what you own – how each holding is managed, and how it should behave in various environments. There are lots of products out there that look great on paper but are set to disappoint, and these need to be weeded out from the genuine article. This takes constant monitoring by our team.
During the financial shock sparked by the coronavirus, we’ve been pleased to see how well these assets have done their job. They helped protect portfolios from the worst of the market falls. One example is the LGT Dynamic Fund. This is a quantitative strategy that invests in broadly defensive and protective assets. As markets went down in the first quarter it went up – and we decided to sell when it had gained 35% since the start of the year. To put this into context… by that point the FTSE 100 had lost about the same amount. By taking profits we were able to lock in gains, and mitigate some of the falls in value of other assets in the portfolios. It also gives us cash to put to work where we see opportunities.
Currently, one of the biggest opportunities we see is in the credit markets. Yields on many corporate bonds are now at levels we haven’t seen for a decade. The bonds of high quality companies are being sold as if they’re heading for bankruptcy, while lower quality company bonds are being priced as if the bailiffs are knocking on the door. This is an example of people letting the lizard doing the thinking for them – see Ben’s piece for the details. We think the outlook for credit is far better than most investors realise, especially given the financial support that governments are giving to businesses across the world – guaranteeing their loans, subsidising their businesses and even paying their staff for them. We’ve been adding to corporate credit accordingly. »
Your Investment Update – Q2 2020
At 7IM we've been beating the drum about diversification for many years. It's been central to our investment process since the company was founded in 2002.”
HAIG BATHGATE
Head of Portfolio Management
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Your Investment Update – Q2 2020
Key Investment Themes
US Inflation Protection – positive
Emerging Market Debt – negative
Every portfolio at 7IM has a Strategic Asset Allocation (SAA), which acts as its long term investment plan. The SAA defines the portfolio’s characteristics and asset class exposure to match its investment goals. We aim to diversify portfolios as much as possible, to avoid them being overly vulnerable to particular asset classes, countries, companies or governments.
Financial markets expect US inflation of around 1.3% per year for the next 30 years. We think this is too pessimistic, particularly in light of the massive fiscal and monetary stimulation associated with the coronavirus recession. We have a position in portfolios that will do well if the market decides that US inflation will rise.
Most 7IM portfolios have a chunky strategic allocation to emerging market debt. Once the coronavirus crisis came along we took this exposure from overweight to underweight, fearing that COVID-19 presents unique challenges to emerging market countries.
Our main tactical themes at present are as follows: US Healthcare – positive Healthcare companies should do well out of ageing in the developed world, and economic growth and ageing in the emerging markets. The sector is defensive, outperforming in difficult periods for equities like March 2020. We have allocated a decent part of our US equity exposure to healthcare, across all portfolios.
Europe Dividends – positive Euro Stoxx 50 Dividends are a financial instrument that measure the expected dividends that will be paid in future years by the EU’s 50 largest companies. They were hammered in March, implying that these firms will slash their dividends to the bone for several years to come. We think this is an over-reaction, and that these future dividends look cheap. Alternatives – positive We hold a diversified basket of alternative strategies that should provide inflation-beating returns over time. These performed well in the February-March 2020 selloff, adding defensive qualities to the portfolios over and above the protection offered by fixed income.
110 105 100 Returns index (31/1/2020=100)
The Tactical Asset Allocation (TAA) process is designed to take a modest amount of risk on top of the SAA, to enhance returns a little. Under normal circumstances the SAA will take 80% or more of portfolio risk, with the TAA taking 20% or less.
95 90 85 80 75 70 65 31/01/2020
07/02/2020
Source: Bloomberg Finance L.P
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Your Investment Update – Q2 2020
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We aim to diversify portfolios as much as possible, to avoid them being overly vulnerable to particular asset classes, countries, companies or governments." How US healthcare has held up Healthcare fell by far less than US equities through the first three weeks of March
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S&P 500 Return Index
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S&P Health Care Return Index
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Your Investment Update – Q2 2020
Featured topic Don't let the lizard loose! If you were to spend a day on the 7IM investment desk, every now and then you’d hear someone refer to the lizard. And you may have seen the lizard mentioned in our articles or presentations from time to time. No, we don’t yet have a team pet.1 The lizard is our shorthand for describing how irrational people can be when financial markets get stressful. Recently we’ve been talking about the lizard far more than normal. Why do we talk about the lizard? The human head is a crowded place. The human head is not a cool, calculating analytical machine – it’s more like a warzone where various bits of the brain fight for control. The biggest battle is between the neocortex and the reptilian complex, or more casually, the ‘reasoner’ and the ‘lizard’. The reasoner wants to take time, analyse issues and think about potential options before calmly committing to a course of action. The lizard is a far older, simpler creature who sees every decision as fight or flight, life or death – needing an immediate, instinctive reaction. In evolutionary terms the lizard has been around a long time; the reasoner is the new kid on the block.
The lizard is quick. Sometimes, that’s exactly what’s needed. If you’re crossing a road and a car comes out of nowhere, you don’t want the reasoner spending five minutes (or even five seconds) calculating relative vectors and momentum, and then politely pointing out that, on balance, the evidence suggests you should move. No, you need the lizard to scuttle you back to safety.
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The lizard always reacts instantly, and always as if it's life-or-death.” And the lizard never switches off – it reacts to every event, every time. One hundred million years ago, daily life consisted of lying motionless in an empty desert, so overreacting to the unexpected was a sensible evolutionary plan. But our modern world is too frantic, too full of stimulation for the lizard and it can’t discriminate between what’s important and what’s not. So the lizard always reacts instantly, and always as if it’s life-or-death. To keep you alive, this is ideal. To keep you calm, this is awful. How much does listening to the lizard cost you?
BEN KUMAR
Senior Investment Strategist
If you had to design the worst possible environment for the lizard, it would be hard to outdo the world of finance with its constant news flow, instant pricing and excitable pundits on CNBC.
Even in normal times, there are always lots of investors letting their lizard loose and quickreacting to markets. When a company releases bad earnings and it's shares fall. When a natural disaster hits a country and the currency plummets. Or a political scandal, or a supply chain problem, or just someone having a bad feeling about life. People who react instantly to negative news by selling are letting their lizards run riot through their portfolios. Studies into investor behaviour have found that over the long term, lizard investors (who tend to buy when markets are rising and sell after they fall) underperform simple buy-and-hold investors. Many of the best days in the market occur shortly after it bottoms out, so by waiting to be sure of a rally before reinvesting, lizard investors buy too late and miss much of the upside. »
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Your Investment Update – Q2 2020
Featured topic Continued As the graph shows, that could be the difference between an initial £100,000 investment in the FTSE 100 at the end of 1999 rising to about £169,000 in April 2020, versus around £111,000 for a lizard who misses the market’s 5 best days – or worse still, £84,000 for a lizard who misses the 10 best days. Can the lizard catch COVID-19? The coronavirus crisis is particularly challenging for the lizard part of our brains. We’re constantly seeing and hearing about illness and death; we have a low-level, daily hum of concern about our health, and those of our families and loved ones. This sets the lizard on edge, all the time. Worse still, when the lizard looks to the reasoner for reassurance, there’s none to be found – we are consciously changing our lifestyles and habits to tackle COVID-19 precisely because there really is a problem. This reinforces the lizard’s initial fear. Given this background, the panicked reaction in financial markets in March is understandable. Genuine real-life fears have triggered financial fears, which have then gone full-circle. And of course, the bad news has not stopped coming. Every weekend brings more information about the disease, its impact and the outlook for humanity. Each week starts the fear cycle anew – and the lizards run wild. 1
How do we cage the lizard? There’s no single, simple answer to how to cage the lizard. For you, our clients, an important first step to staying invested is outsourcing your portfolio decisions to us. Having a plan in place, and someone trusted to talk to is a fantastic way to keep calm. Of course, it’s also up to us at 7IM to make sure that we don’t let our lizards escape. Step one is simply acknowledging that the lizard exists – that we aren’t perfect. Having a team rather than individuals is also crucial, as it mitigates the problems that can come with a star manager, no matter how smart and focussed he or she might be. Most of all, though, we have a tried and tested investment process, designed to deal with uncertain and fast-moving markets. Part of the process is quantitative, looking at dashboards and models covering different economic and market indicators. Part of it is qualitative, discussing policy, views and trends rather than hard numbers. And part of the process is ensuring that we are talking to one another, that information and views are shared clearly and honestly.
Cards on the table, my parents actually do own a lizard… a bearded dragon called Dexter.
This lets us – makes us, even – look forward, rather than back. It keeps the lizard in a cage, and lets the reasoner do the thinking. We are confident that our ability to keep the lizard under control and avoid emotional responses to markets will lead to smoother investment returns in the long run, and work to the benefit of all our clients.
£250,000
£200,000
£150,000
£100,000
£50,000
£0 2000
2002
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People who instantly react to negative news by selling are letting their lizards run riot through their portfolios.” Lizard vs Reasoner Over the long term, lizards, who let their emotions dictate when they buy and sell, underperform reasoners, who buy-and-hold.
£169,286
£110,917 £84,421
2006
2008
2010
Reasoner who stayed fully invested
Source: Bloomberg Finance L.P.
2012
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Lizard who missed 5 best days
2016
2018
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Lizard who missed 10 best days
Meet the teams Investment Management Team Martyn Surguy Chief Investment Officer
Tony Lawrence Senior Investment Manager
ACA Chartered Accountant, MCSI, CISI Level 4, 30 years of industry experience.
CFA and CAIA, 18 years of industry experience.
Terence Moll Head of Investment Strategy
Christopher Cowell Investment Manager
M.Phil. Ph.D. in Economics, 27 years of industry experience.
PhD in Biochemistry, MSc Molecular Biology, 4 years of industry experience.
Haig Bathgate Head of Portfolio Management
Jack Turner Investment Manager
CFA, 22 years of industry experience.
CFA, 10 years of industry experience.
Camilla Ritchie Senior Investment Manager
Ahmer Tirmizi Senior Investment Strategist
IMC, 30 years of industry experience.
MSc in Economics and Finance, 10 years of industry experience.
Peter Sleep Senior Investment Manager 29 years of industry experience.
Stephen Penfold Senior Investment Manager 35 years of industry experience.
Matthew Yeates Senior Investment Manager CFA / Certified Financial Risk Manager, 7 years of industry experience. Duncan Blyth Senior Investment Manager CFA, 22 years of industry experience.
Ben Kumar Senior Investment Strategist CFA, 8 years of industry experience.
Harriet Massie Business Manager Level 3 Candidate in the CFA program, 4 years of industry experience. Katy Stoves Investment Analyst CFA, 9 years of industry experience.
Risk Team Joe Cooper Head of Risk and Portfolio Analytics CFA / MSc in Applied Economics, 9 years of industry experience. Alex Mitsialis Performance and Risk Analyst MSc / CFA, 5 years of industry experience.
Aaron Chhokar Investment Risk Analyst MSc / MEng 2 year of industry experience.
Hugo Brown Risk Analyst BEng, 1 year of industry experience.
Haris Slamnik Risk Developer Risk Developer, MSc, 1 year of industry experience.
www.7im.co.uk Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority, the Jersey Financial Services Commission and the Guernsey Financial Services Commission. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales number OC378740.
