Your investment update Q1 2021
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 –  Q1 2021
Contents 04
Welcome
Martyn Surguy Chief Investment Officer 06
Strategy You don't have to be an optimist to buy equities Ahmer Tirmizi Senior Investment Strategist
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Portfolio implementation Hello, Mr UK Government. How can I help you today? Matthew Yeates Head of Alternatives & Quantitative Strategy
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Featured topic When ESG becomes the mainstream Terence Moll Head of Investment Strategy
Visit us at www.7im.co.uk to find out more about our latest news and views.
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Your Investment Update – Q1 2021
Welcome MARTYN SURGUY Chief Investment Officer
2020 was one of the strangest and most remarkable years in modern economic, social and financial history. It began with the most disruptive virus in a century. We saw a sudden stop to the global economy, followed by the largest bouts of stimulus ever. Our ways of living changed abruptly, with political and social strains pushed towards breaking point. It’s not yet clear which of the changes will be permanent and which will fade into memory.
Who knew in January what would happen in the next 11 months? Owning a sensible spread of holdings, combined with the cushion provided by a judicious selection of alternative investments, enabled our portfolios to cope well. Matthew Yeates talks through the reasons why we’re holding alternatives in many of our portfolios later on.
Our team’s challenge throughout the year was to put many of these social and political issues aside and concentrate on the investment opportunities and risks that we faced. As ever, our fundamental investment beliefs and core principles helped us to do that.
Of course, market conditions evolved as the year progressed, so being nimble along the way was also important. Better news emerged in the spring as central banks came to the rescue by delivering synchronised stimulus packages that were faster and larger than ever before – the global economy would not be allowed to slide into depression.
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Owning a sensible spread of holdings, combined with the cushion provided by a judicious selection of alternative investments, enabled our portfolios to cope well." As the summer progressed, we began to see evidence that not only was the world going to avoid disaster, but it could be in a better shape than many were ready to believe. In late summer we added to a selection of ‘equity laggards’ that had not participated much in the rebound. Ahmer Tirmizi gives an insight into how our process identified this opportunity in his piece. This positioning was uncomfortable for a time as the pandemic situation deteriorated and economic fears grew in the autumn. But what is comfortable is rarely the same as what is profitable, and we were not minded to change course. And then, suddenly, the landscape shifted again in November, with vaccines and a market-friendly outcome to the US election. Our relatively non-consensual positioning in September became the norm almost overnight.
So what now? The consensus is not always wrong and we intend to maintain our constructive positioning. 2021 should bring better news on both the pandemic and economic fronts. There will be new challenges, of course, not least of which will be the gradual removal of stimulus. We will remain flexible, while trusting the beliefs and process that served us well in 2020. We will also watch closely some of the longer-term economic and financial shifts that are taking place – such as the rise of Environmental, Social and Governance (ESG) investing, highlighted by Terence Moll later on.
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Your Investment Update – Q1 2021
Strategy You don't have to be an optimist to buy equities Life is full of simplifying analogies. You might look for a needle in a haystack, think about life as being like a box of chocolates or work out how useless it is to rearrange deckchairs on a sinking ship. The financial industry has its analogies too. The stock market is like a rollercoaster because black swans appear from time to time and derail an economy. Apparently. Good analogies can create easyto-understand images, help compare and contrast different situations – and even inspire people to action. The COVID recession needed simplifying If there was ever a time the world needed simplifying analogies, 2020 was it. For starters, the only comparison we had to this situation was the Spanish flu of 1918 – and today’s investors weren’t around then.
Events in 2020 were hard to comprehend. China saw fit to shut down and seal off a city of 11 million people. And the virus was so severe that they went on to build a brand new hospital within six days! That scale of response is usually reserved for Matt Damon movies. The bad health news spread across the world. Hospitals ran out of space, medical equipment was in short supply and mortality rates tragically surged in some places. Economies suffered the consequences. Everywhere you looked the economic news was off the scale. Oil prices went negative (huh?), nearly 20 million Americans lost their jobs in just two months and the global airline industry ground to a halt (not an analogy this time).
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In March, we reviewed the possible range of outcomes from the COVID pandemic. How effective would lockdowns be? Would vaccines arrive soon? What would people spend money on? Was the policy response big enough?� The situation was dizzying. People wanted answers. Across the investments industry four possible economic outcomes were widely discussed, with the labels V, W, U and L. Think of those letters as shapes on a chart describing the trajectory of the global economy. At 7IM, we developed our own versions with slightly different labels: V+, V, U and L. They helped us to simplify the world, filter out the noise and focus on the most important questions. Through the year, we used these scenarios to anchor our portfolio positioning. >>
AHMER TIRMIZI
Senior Investment Strategist
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Your Investment Update – Q1 2021
Strategy Continued
The V+ scenario is already playing out In March, we reviewed the possible range of outcomes from the COVID pandemic. How effective would lockdowns be? Would vaccines arrive soon? What would people spend money on? Was the policy response big enough? We used these questions to model a range of possible scenarios for the US economy in the next two years. As the evidence accumulated we decided that ‘V+’ was the most likely outcome. And that’s exactly what is happening. Source: 7IM
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US real GDP index (Dec 2019 = 100)
In March, this is where we thought the US economy might go V+
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The fiscal response removed ‘L’ – rebalance portfolios
No repeat of the ’08 financial crisis ‘U’ – selectively add risk
The closest historical comparison to an ‘L’ shaped world – the economy collapsing then flatlining for years – was the Great Depression of the 1930s. That was driven by a combination of bank failures and inadequate policy responses.
Investors who lived through the 2008 financial crisis remember a slew of ‘end of the world’ predictions and Great Depression comparisons. But that recovery didn’t turn out to be an ‘L’, instead it’s the closest example we have to a ‘U’.
We concluded that a banking crisis in 2020-21 was unlikely, due to governments and central bankers racing into action. Put together stimulus cheques, furlough schemes, state-backed business loans and open-ended central bank support and you have a huge and breathtakingly quick policy response.
In 2008, the global construction sector had overbuilt, real estate was on its knees and the financial sector was in trouble. These key job-creators lost the ability to create jobs and incomes, leading to drawn out U-shaped recoveries. Was the COVID recession going to be drawn out too?
It put a floor under the global economy and made ‘L’ highly unlikely. The worst outcome was averted. In response, we had the confidence to rebalance portfolios through March by reducing what had done well (alternatives and healthcare) and buying what had done poorly (equities and real estate investment trusts (REITs).
No. Those sectors that create the most jobs have remained open – technology, real estate and manufacturing. Instead, the COVID recession has impacted sectors that don’t create many jobs, like travel, tourism and recreation. For example, five times as many people work for booming US car dealerships than in the hurting airlines industry. >>
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Your Investment Update – Q1 2021
Strategy Continued
The world economy is not firing on all cylinders but its most important cylinders are firing. This means a 2008-style ‘U’ recovery is unlikely. But in March, high yield markets were pricing in defaults three times greater than actually occurred in 2008. So in April we added risk to portfolios by buying cheap credit markets. The vaccine news was a shot against ‘V’ – buy the laggards The stimulus packages ended up being highly successful, with companies bailed out, wages being subsidised and widespread mortgage holidays. This led to a surge in global household spending power: in the US the money in people’s bank accounts is close to $2tn, 10% of the economy, but they are struggling to spend it! Moreover, the crucial economic sectors were inadvertently boosted by lockdowns. Companies invested in technology so that people could work from home. They moved houses in search of gardens and studies. And they spent a record amount on goods as they had nothing else to do.
And so there is just one thing holding back the global recovery: lockdowns. Remove these and you not only get a ‘V’ but a ‘V+’. Our work on the virus back in the summer suggested we were likely to see lockdowns being eased faster than expected, and positioned portfolios accordingly. We took profits on credit and started by buying US value stocks (Berkshire Hathaway) and trade-sensitive exposures (emerging market equities). We have since added smaller company stocks (global mid-caps) which should benefit from economies reopening everywhere. The vaccine news was an early shot our portfolios were waiting for.
Your Investment Update – Q1 2021
But it’s not 'V+' or nothing Finding optimistic news in 2020 has been challenging. Instead, our process led us towards buying equities and credit by striking out the most pessimistic forecasts. Our clients are positioned to do well in a ‘V+’ world – which we think is the most likely. But we still hold a number of defensive positions like alternatives and healthcare for the ‘L’ world. And we continue to see opportunities in some credit markets like US mortgages that should do well in ‘U’ or ‘V’ worlds. In other words, we don’t put all our eggs in one basket. We prefer to give our passengers a smooth ride. But when opportunities arise, it’s best to board the train before it leaves the station.
The world economy is not firing on all cylinders but its most important cylinders are firing.”
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Your Investment Update – Q1 2021
Portfolio implementation Hello, Mr UK Government. How can I help you today? How much would you like to receive for lending money to the UK government? This can be a tricky question to think about. A bank might approach it as follows: “Thanks for coming in today, Mr UK Government. Just to start: What’s your net annual income?” “It varies, but last year it was around £800bn.” “I see. Has COVID made it harder to plan financially?” “A little. We spent more on eating out and childcare this year.” You can probably tell that I thought about this recently. It’s crazy to think about a government going through a similar process and being told how much its borrowing would cost. Meanwhile, Mr UK Government currently pays just under -0.1% to loan money from us over 5 years. We pay the government to borrow from us!
Loaning to governments is done through the global bond market. Traditionally, government bonds would be a core part of many client portfolios, balancing the risk of cyclical equities with the lower risk and guaranteed payments of bonds. But those large allocations in traditional portfolios are now returning negative rates of interest. What do you do when faced with the prospect of a ‘low risk’ investment that’s guaranteed to lose you money? At 7IM we look elsewhere for those sort of returns, by combining different types of bonds and alternative assets. For a start, our long-term or strategic asset allocations (SAAs) are built with half an eye on this problem. We place a chunk of assets in corporate debt: loans to companies rather than governments. These pay a little more than government bonds.
Alternative assets and merger arbitrage To help balance the extra risk that comes with lending to companies, we also have built experience in and a focus on so-called alternative assets. Alternatives provide for other ways to generate dependable returns than government bonds. We focus on liquid lower-risk strategies, where we can access money quickly and easily should we need it. This year we added a strategy investing in mergers and acquisitions to all of our portfolios. Investing in companies going through a merger can be done in a way to almost guarantee a return should the merger go through (termed merger arbitrage). The risk is that the deal fails to materialise but this risk is often much lower than the return available implies.
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The strategy is like owning the profits of a company that provides insurance against mergers failing. Compared to the guaranteed loss on offer from government bonds, we think this source of return is attractive for portfolios.
To help balance the extra risk that comes with lending to companies, we also have built experience in and a focus on so-called alternative assets.”
That means we don’t have to be on the other side of the bank counter, handing out money to governments looking to borrow and paying them for the privilege. Mr UK Government will have to look elsewhere than a 7IM portfolio for that loan!
MATTHEW YEATES
Head of Alternatives & Quantitative Strategy
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Your Investment Update – Q1 2021
Featured topic When ESG becomes the mainstream Once upon a time Environmental, Social and Governmental (ESG) investing was widely regarded as weird and whacky. You thought of earnest idealists with long hair and sandals who lacked hard-nosed business experience. How the world has changed! ESG investing has raced ahead in the last ten years… and COVID-19 has speeded it up for good. Why? Three huge and persistent forces are driving the growth of ESG investing worldwide: technology, regulations, and client demand. And they have a long, long way to go.
1 Technology The first force driving ESG investing is technology. Over the last few years, clean tech – the kind of technology associated with ESG companies – has raced ahead. Productivity is up, and prices have fallen. So in many areas, it’s now cheaper to produce using clean technology than by using the old dirty stuff. For example, in the late 1970s solar electricity was expensive and clunky, as shown in the graph. People laughed at it. But its price has fallen since to one four hundredth of 1977 levels. Suddenly it’s the cheapest electricity in the world. This is the ultimate reason why fossil fuel stocks are doomed in the long run. Clean tech stocks will outcompete them. Why? Because fossil fuels are a resource. The more you mine of a resource, the more costs tend to rise. Whereas solar power is a technology. The more solar electricity develops, the more productivity rises and costs fall. And they will go on falling.
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Renewable energy is becoming cheaper and cheaper The costs of renewable energy, led by wind and solar, have been plunging for decades, and have crossed the turning point. Solar power is now super-cheap. In much of the world, it’s cheaper to produce energy using clean technology than by using the old dirty stuff. Source: https://www.freeingenergy.com
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TERENCE MOLL
Head of Investment Strategy
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The global demand for oil crashed in 2020, and fossil fuel stocks were hammered across the board. It will take a while for global oil demand to recover, and it may never get back to 2019 levels. Peak oil is probably past. Clean energy will continue taking over instead. And that’s why ESG stocks should do well in the long run. Dirty, nasty, badly run companies will get crushed by their clean, well-managed, tech-savvy competitors. Taking a 20-year view, I am not betting on fossil fuel and related companies. >>
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Your Investment Update – Q1 2021
Featured topic Continued
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Regulation
Client demand
A second reason why companies are going ESG is regulation. Lots of politicians and governments want a cleaner, safer and better-managed world, and are introducing regulations forcing companies and investors to improve their behaviour. The EU and UK have been leaders in this, both targeting zero-emissions economies by 2050.
A third factor driving ESG investing is client demand. Investors increasingly want their money to be used not only to make money, but to make the world a better place – or at the very least, not make it worse. We see this especially with our younger clients.
The regulatory drive will pick up further after COVID-19. Governments have realised there are lots of nasty risks out there that they had underestimated – not only public health, which we now know all about, but also inequality, poverty and the environment. More risk-aware politicians will introduce more ESG regulations, and constrain the activities of dodgy companies more and more. In September 2020, President Xi announced that China would go carbonneutral by 2060. That was huge news, since China is by far the world’s largest polluter, responsible for 28% of the world’s CO2 emissions – more than US, Europe, Japan, South Korea and Canada put together. China’s coal-fired power plants are hopelessly inefficient, and its authorities want to join the renewables bandwagon as soon as possible.
Inflows into ESG products were strong last year. One reason is that the pandemic reminded us that human life is short and fragile. It makes us think about our responsibilities to the future. It makes us think about the kind of planet we will be leaving to our grandchildren. And that points to ESG investing. Likewise, consumers increasingly want to buy sustainable products. A study by the NYU Stern Center for Sustainable Business found that sustainable or green products accounted for 16% of the consumer goods market in 2019. Ethically marketed products drove half of the growth in the entire consumer sector.
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Stocks with high ESG ratings also did well in 2020 because better managed companies that take care of the environment and worry about their social impact are less risky than their competitors.” Strong performance in 2020 On the whole, companies with good ESG ratings performed well in 2020. For example, MSCI has an ESG Select Index for the US, which targets 100 companies with favourable ESG features. It outperformed the US market by 9.8% in 2020. That’s pretty good going! These 100 stocks did well partly because they had a fair exposure to technology, which had a wonderful 2020. Tech companies tend to be well-managed and have relatively low emissions, so get good ESG scores. Stocks with high ESG ratings also did well in 2020 because better managed companies that take care of the environment and worry about their social impact are less risky than their competitors. They tend to be less vulnerable to nasty extreme events like COVID-19.
The general theme here is that ESG indices are exposed to winning companies of the future and have less exposure to the losers of the past. And 2020 made many long-term winners and losers crystal clear. How far can ESG go? The three forces described above have only just got going. Clean tech will continue to improve, and to outcompete fossil fuels further. Firms that behave badly will increasingly be regulated out of existence. And investors and consumers will demand more sustainable products. Within a few years, I suspect, most of the world’s dirtiest and socially irresponsible companies will either have changed their spots or be saying their long goodbyes. Technology and regulation will take them out.
By 2030, most investing will be ESG. It will become the norm. We will automatically think about company governance, emissions, impact on biodiversity, climate vulnerability and social policies before we invest. By then, nonESG investing will seem weird and old-fashioned – and unfit for the 21st century. This is good news for the world. Taken together, clean tech, strong policies from many governments and investor and consumer demand will lead to global emissions plunging over the next 30 years.
Meet the teams Investment Management Team Martyn Surguy Chief Investment Officer
Christopher Cowell Quantitative Investment Strategist
ACA Chartered Accountant, MCSI, CISI Level 4, 31 years of industry experience.
PhD, MSc, CFA, 6 years of industry experience.
Terence Moll Head of Investment Strategy
Jack Turner Investment Manager
M.Phil. Ph.D. in Economics, 29 years of industry experience.
CFA, 11 years of industry experience.
Haig Bathgate Head of Portfolio Management
Fraser Harker Investment Analyst
CFA, 23 years of industry experience.
CFA, 5 years of industry experience.
Camilla Ritchie Senior Investment Manager
Salim Jaffar Investment Analyst
IMC, 31 years of industry experience.
BA (Cantab) in Economics, 1 year of industry experience.
Peter Sleep Senior Investment Manager
Ahmer Tirmizi Senior Investment Strategist
30 years of industry experience.
MSc in Economics and Finance, 12 years of industry experience.
Stephen Penfold Senior Investment Manager
Ben Kumar Senior Investment Strategist
36 years of industry experience.
CFA, 10 years of industry experience.
Duncan Blyth Senior Investment Manager
Matthew Yeates Head of Alternatives and Quantative Strategy
CFA, 23 years of industry experience.
CFA / Certified Financial Risk Manager, 9 years of industry experience.
Tony Lawrence Senior Investment Manager
Tiziano Hu Junior Quantative Strategist
CFA and CAIA, 19 years of industry experience.
MSc in Financial Technology, less than 1 year of industry experience.
Risk Team Joe Cooper Head of Risk and Portfolio Analytics CFA / MSc in Applied Economics, 10 years of industry experience. Alex Mitsialis Performance and Risk Analyst MSc / CFA, 6 years of industry experience.
Aaron Chhokar Investment Risk Analyst MSc / MEng 3 years of industry experience.
Hugo Brown Risk Analyst BEng, 2 years of industry experience.
Haris Slamnik Risk Developer MSc, 2 year of industry experience.
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