GLOBAL EQUITIES GO VIRAL

An almost unprecedented worldwide health emergency has sent global equity markets into a tailspin. Investors will recover, but they’ll need cool heads. Harrison Worley writes.

Everybody knows the one about how things might not go to plan. It’s not often directly quoted from its original source these days, but it goes like this: The best-laid plans of mice and men often go awry. It’s safe to say investors are feeling its meaning more now than ever before.

Before the COVID-19 crisis came along, investors were considering how themes such as late cycle market behaviour, central bank policy, and the implications of climate change – among others – would impact their global equity strategies, according to the head of JANA’s global equities research team, Matt Gadsden 01 . Investors, with an eye to the future already had their plans well in place. Alas, nobody can predict the future. And so, what started as just another news story has quickly morphed into a market-melting global health emergency, leaving those best laid plans in its wake.

Since February 20, the ASX200 index has lost more than 33% of its value at the time of writing. But that’s just here in Australia. Take a look around the world and it’s plain to see that nobody saw this coming. The value of significant global indices have quite literally fallen off a cliff over the past few weeks.

The MSCI World index sat at US$2434.952 at market close on February 12, while its emerging market-inclusive sibling, the MSCI ACWI index closed at USD$581.025 on the same day. (Figure 1). At time of writing both have lost around 30% of their value.

But is it the end of the world? The answer depends on several variables. For some investors, maybe it is. Those close to retiring are surely having flashbacks to the Global Financial Crisis, concerned they may not be able to regain any losses they suffer as they dance on the precipice of their drawdown phase.

“The scars from the GFC are definitely still there for many middle aged and older clients,” JustInvest’s James Baird 02 says. And while that reality is sobering for those investors, the experts are at pains to remind the public – and the wealth management industry – that the COVID-19 crisis is firstly a global health risk that needs to be effectively managed for the betterment of humanity. And secondly, one of several crises financial markets have powered through before, and will almost certainly triumph over again. Still, for those with serious skin in the game – be they financial advisers and their clients, or superannuation trustees and their members – there’s a myriad of significant considerations to make.

Perhaps most intriguing – and pressing right now – is what to do with global equity allocations, especially in light of the severe damage doled out to those aforementioned indices. It isn’t hard to understand why. Speaking to Financial Standard before the crisis deepened, Franklin Templeton senior vice president and portfolio manager Don Huber 03 said investors were using the firm’s global equity funds to strengthen their portfolios by way of geographical diversification.

At the time, he said investors were particularly focused on active management, which could also protect investors from the type of index-smashing economic event currently wreaking havoc.

“Clearly, one of the main reasons investors include global equities in their portfolios, in combination with home market equity investments, is to provide diversification,” Huber said.

“I think investors are looking for strategies that are different from the index, not benchmark hugging, which move outside of the mega cap companies that dominate indices.”

Huber’s sentiment seems tightly connected to reality.

According to Rainmaker analysis, almost 35% of AustralianSuper’s mammoth $126.7 billion balanced investment option is invested in global equities. At $43.9 billion – far heavier than any other asset class – the attraction of global equities to the nation’s largest super fund is clear.

Smaller investors have followed suit. Australian Tax Office data shows Australia’s self-managed super funds held well over $8.8 billion in overseas shares as at September 2019.

State Street Global Advisors local head of investments, Jonathan Shead 04 , says Australian investors have slowly but surely expanded their investment horizons beyond our shores, where they’ve typically been heavily focused.

It is very difficult to work out what the impact is going to be on global growth. Jonathan Shead So much so, the firm’s global equity SPDR ETFs have grown by 59% over the last two years. “We consider the investment domestic bias to be diminishing over time,” Shead says.

“Advisers are increasingly educating their clients on the benefits of diversification and, with more products available, it has never been easier for investors to access global equities.”

Timing is everything, right? But has this newly realised popularity in investing beyond Australia’s (temporarily-closed) borders come at the worst possible time?

With the COVID-19 virus quite literally shutting down several economies, – investors with any global equity exposure are asking the far-more-than-$1-million question: how big is this problem?

The answer depends on who you speak to. Shead says that at the moment, it’s hard to know. “Really at this point it is very difficult to work out what the impact is going to be on global growth and then what impact it’s going to have on corporate earnings, and hence where the share market will be in 12 months’ time,” he says. This is perhaps why he hasn’t detected any “panicky” activity within SSGA’s large institutional portfolios so far.

“We haven’t seen reactionary selling or any kind of reactionary buying,” Shead says.

While his statement is broad, Shead is adamant panic hasn’t set in just yet, at least among the firm’s larger clients.

“It doesn’t mean that our large institutional investors aren’t doing anything,” he says.

“It just means that [in that] part of the portfolio that we hold for them, we’re not seeing evidence of that [panic].”

Others, such as Gadsden, say it’s a big enough issue that active managers are well and truly on notice. “All things being equal, a more volatile investment market environment with increased stock dispersion should be more conducive for active investing,” Gadsden says.

Either way, if you’re an investor with a decent allocation to global equities, you’ve got several decisions to make. Not just now, but over the course of the next few months. So what are the options?

Cool heads For the most part, the experts are preaching calm. Firstly, as Pitcher Partners Sydney wealth management partner Charlie Viola 05 says, global equities should be treated the same as any other asset class he invests in for clients: with a focus on diversity and a thorough top-down investment approach.

“When we look at global equities as an asset class, we very much take that top down approach,” Viola says.

“We have a look at what’s driving the economy and where earnings are coming from.”

Explaining his strategy, Viola says the global equities allocation is then split between a direct international equity portfolio and a bunch of ETFs. “We have a full analyst team here that do the qual and quant on a direct model portfolio that we utilise, and we treat international equities no different to what we do domestic ones,” Viola says. “We’re seeking out key competitive advantages, good quality companies, good continuity of earnings. At the end of the day, we really want to own quality businesses that can withstand various events in market.”

Pitcher Partners’ model portfolio at the moment consists of Apple, Abbot Laboratories, Alibaba, Google, Johnson and Johnson, Microsoft, Nestle and Union Pacific, among others.

“So we’re very much looking for that stable, large cap, global leading [company]. We’re looking for those absolute best-of-breed-style companies,” Viola says.

He says the firm’s use of ETFs is just “like everybody else’s”, to obtain exposure to specific sectors, using fund managers with good track records that can offer something different what the direct equities portfolio is bringing to the table. “We have tended to put a reasonable allocation to funds like Magellan, Aoris, and Loftus Peak, because we like the managers, we like their approach,” he points out.

“We like the fact that what’s on the label is in the bottle in terms of the investment philosophy.” Viola says the crisis has become the dominant force in conversations between himself and his clients over recent weeks, though points out his clients aren’t too concerned, because they believe in the investment process.

“It’s clear that it’s dominated conversations,” he says.

“I don’t think that there’s a heap of fear around. We’ve worked really hard over the last couple of weeks to stay as close as we can to clients.”

The FS Power50 adviser says daily investor notes have focused on how the situation is unfolding. Clients understand and appreciate the fact that the crisis presents non-diversifiable risk which pulls the performance of the global equities portfolio down. The firm’s key investment filter, Viola says, is the risk of impairment.

“What we don’t want to see is these types of events occur, and we have assets that are genuinely becoming impaired or don’t have an ability to generate earnings into the future,” Viola points out.

“And we continue to remind clients about that. These companies will continue to generate earnings, these companies will continue to have solid quality businesses through the other end of these kind of events.”

For ethical investment specialist and JustInvest planner James Baird, the crisis is just another bump on a long road for investors. Instead of focusing their energy on the financial impact of the crisis, Baird says his clients are more interested in the positive impacts their global equity investments will make.

“Global equities is a long term asset class, and we know that there will be ups and downs in markets along the way,” Baird says.

“The coronavirus won’t be around forever, so it doesn’t change our long term views. Our clients are not only interested in performance figures – they also want to understand how the companies that they invest in are creating positive impacts.”

The big end of town Australia’s large institutional investors seem to be reading from the same songbook as financial advisers.

Seemingly also not too concerned is the $96 billion Queensland government super fund, QSuper. “Our strategy is based on the long-term. Most of our investors are focused on the long-term,” QSuper chief investment officer Charles Woodhouse 06 says. The fund famously employs a risk-allocation strategy instead of a typical asset allocation strategy, a decision made in the aftermath of the global financial crisis, which saw member accounts take a hit. A decade later, it’s prepared for precisely this kind of market phenomenon.

“If you measured us against a traditional strategy, we would have a lot less equities than most,” Woodhouse says.

The QSuper investment boss says that while the fund’s equity allocation has performed “basically down, in-line with [the] market”, its exposure to asset classes with a similar level of expected return – such as long-term bonds – have not only provided protection, but pushed the fund to excel. “Our long term bonds would be really doing the heavy lifting there to help smooth that ride out for our investors,” he says.

“It [QSuper’s strategy] recognises that there are periods of market volatility, and it helps if we can find diversifying alternatives that we can allocate to which can still generate strong returns over the long term, but can help smooth the ride through these periods of uncertainty, particularly uncertainty around listed equities.”

Despite that, the fund still parks around $18 billion in international equities, which is significantly more than what it puts into local listed equities. Woodhouse, like others, points to the benefits of diversification.

“We would have lower exposure to Australian shares than most might have. But it’s spread out over a range of different markets,” he says.

“We have a bit of emerging market exposure, but we’re also quite spread out across developed market countries relative to a traditional sort of market cap weighted country exposure.”

Contrasting this, Cbus is more balanced, splitting its equity exposure almost evenly between overseas and Aussie equities. Currently, the fund’s default option allocates around 24% to global equities, while about 6% is dedicated to emerging markets.

Cbus deputy chief investment officer Brett Chatfield says the fund’s approach is largely active, and incorporates a mixture of fundamental active managers and an internal strategy, which accounts for around 17% of the global equity allocation.

Meanwhile, Cbus global equities senior portfolio manager Lyn Foo 07 says the fund’s internal strategy runs two funds. One is focused on the US and Europe, while the other invests exclusively in emerging markets, including China.

Foo says the fund’s stock picking is based on a bottom up, concentrated approach.

“We invest in what we deem as the highest quality assets,” she says.

“So those are where we have a high conviction that these companies have very strong competitive advantages, which we think will lead to excess returns on the long term basis, and which operate in attractive industry structures.”

Companies with a high level of recurring earnings – described by Foo as “sticky, repeatable products” – and barriers to entry such as brand name, distribution and scale capabilities, and product innovation.

“We like exposure to the emerging market middle class. And you get that through a variety of ways,” she says.

Pulled together with a range of factor and beta strategies and an objective to outperform the market by around 1.5% per annum on a rolling five year basis, it’s clear the fund’s approach is sophisticated.

“While we didn’t predict this event, the structure of the portfolio is very diversified to help buffer against events such as this,” Cbus head of asset allocation Tim Ridley says.

“The portfolio structure is designed to have cushioning elements for events such as this, so you’re not seeing the full effect of equities going down.

This explains why the $56 billion fund simply isn’t scrambling amid the market turmoil. Instead, it’s looking to double down. “One thing we are conscious of, is episodes like this typically provide favourable pricing for new investments because there’s so much risk aversion priced into the market,” Ridley says.

While understanding of the sensitivities involved with investing amid a delicate and tragic global health emergency, Cbus recognises its role in managing the investments of its members.

“So that’s one of the things that we are considering on a forward looking basis: At what time does it look to be a good time to be purchasing more global equities?” Ridley adds.

He says the environment created by the crisis is “very unusual”, despite being similar in some ways to the GFC.

“The market stress that we see right now is roughly where we got to at the peak levels of the GFC,” he says.

Ridley says that while the two events are similar, it’s the speed at which the crisis has deepened, with only a few weeks from market peak to the same levels of stress the GFC eventually reached around a year after the peak of October 2007.

Why this is important, Ridley says, is because the speed of the transmission is so high that investors can’t quite keep up. As such, he says the fund is dealing with an issue that is not only difficult to contain, but without proper precedent. “We don’t have templates historically to lean on to say ‘Well this is what we think should happen given what has happened in the past,’” Ridley says.“Cbus has a large investment team of around 100 people who are extremely committed to ensuring that the membership receive the best possible outcomes in a very difficult investment environment.” Ridley says the investment team have embraced the challenge, highlighting that the team is working extremely hard to manage members’ investments.

When opportunity knocks Huber says the market volatility comes as not only investors, but all people, “seek some degree of clarity on the depth and duration of the coronavirus health crisis”. “We remain focused on investing in high quality companies with strong balance sheets that will persevere long-term despite the near-term uncertainty,” Huber says. “In an environment marked by uncertainty and turbulent markets, we believe that active management supported by strong risk management offers a compelling proposition.” Asked whether sentiment among superannuation funds at the moment is that active global equities managers must shine in this crisis – or find themselves replaced by passive providers – Gadsden agrees. But he does so with a couple of caveats: that the market seeks safety irrelevant of valuations, and that managers are benchmarked according to respective styles.

“Consistent with greater potential for dispersion for the forward looking prospects of companies, JANA believes that opportunities arise in times of crisis and the only way to harness this is through active management,” Gadsden says.

Frontier Advisors head of equities Fraser Murray 08 agrees, and says active managers must use the next 12 months to prove the management fees they charge.

“I think that’s a reasonable assertion,” he says.

However he points out that it’s still early to determine the success or failure of active global equities management so far.

“[On the] 20th of February we were still at market highs,” he notes.

“We’ve obviously had a steep decline since, but it’s only 20 days to be talking about active managers and how they’ve performed.

“I think there’s probably a lot more water under the bridge before you’d start assessing how your active managers have performed through what’s obviously a difficult period.” Gadsden says headwinds to active management have persisted in the post-GFC environment, as the popularity of passive and index investing has grown among investors.

However, he says the tension posed by the dynamics of macros factors, and “wild sentiment swings” will come under pressure after a market shock similar to this crisis.

“While the active versus passive debate will endure, we don’t see it a mutually exclusive consideration; rather we see both as having roles in portfolios depending on investor preferences and portfolio objectives,” Gadsden says.

So with active management under pressure to perform, where’s the smart money heading? “Asian equities and Chinese equities have actually been relative outperformers during this period of volatility in global equities,” Antipodes Partners chief investment officer Jacob Mitchell 09 says.

The market stress that we see right now is roughly where we got to at the peak levels of the GFC. Tom Ridley According to Mitchell, it’s arguable China’s response included a relative quickly shutdown, which could lead the nation to recovery quicker.

“It’s also starting to warm up. It’s going to take a while before that makes a difference to the spread of the virus, but it seems like most of the science indicates that given the common cold is a coronavirus, these things are less likely to spread in a warmer environment,” he says.

Mitchell says Antipodes believes China is starting to reintroduce normalcy to day-to-day life in the nation, which he says will make a big difference to important supply chains.

“We think selectively there’s opportunities in some of the higher quality consumer related exposures,” Mitchell says.

“Some of the e-commerce beneficiaries like Alibaba, or a high quality restaurant operator like Yum China, which operates the KFC and Pizza Hut business in China. It’s the largest chain restaurant operator in China.”

Mitchell says those stocks can be bought on multiples which he says “are pretty interesting” given their rates of growth.

Elsewhere, Mitchell says one of the crisis’ major impacts will be to speed up some of the secular changes the fund thought to be in play already, including the way people shop, andconsume food and content.

“The solution to COVID-19, is sadly, social distancing,” he says.

“And social distancing means we do a lot more stuff online. So it speeds up some of the secular changes.”

He believes that after experiencing the benefits of online grocery shopping or food delivery services, some “slow adopters” may never return to their old habits. Additionally, he says investors should be on the lookout for markets where governments are happy to introduce stimulus measures, noting it could become a permanent feature of economic policy.

“It’s really a question of who has the most, if you like, dry powder,” he says.

“Broadly speaking, Asia has reasonable ammunition. Europe has been in fiscal austerity mode. The fiscal surpluses in Europe tend to be in the north, but even in the southern parts of Europe, there has been a lot of fiscal repair. And we’d expect that to be used in the short term for income support, and specific support for businesses.”

He says in the longer-term, if the crisis was a structural shift, investors should consider what governments will use that dry powder for.

In places like Europe, initiatives such as subsidies to support the adoption of electric cars might be installed, underpinning the value of electrical vehicle stocks. Whereas stimulus may be pushed towards subsidising the upgrade of housing, he muses.

Whatever the case, there’s value for investors who can see through the panic, and keep a cool head. fs