PruFund Growth & PruFund Cautious Review of 2020 to end April
from the M&G Treasury & Investment Office
A longer update from the M&G Treasury & Investment Office (T&IO) following an exceptional period of investor nervousness and market sell offs driven by a human event and not economics.
Summary – a lot of bad news
- Coronavirus has had a dramatic effect on markets worldwide
- economies went into lock down with populations self-isolating
- a collapse in business confidence, employment and consumer spending as evidenced by economic data
- plunging the world into a global recession
- Markets experienced some of the highest volatility and sharpest declines since the Global Financial Crisis (GFC)
- at one stage the S&P fell nearly 34% from its February 2020 highs
- the FTSE All Share suffered its sharpest sell-off in history
- the VIX index spiked to ~82, higher than during the GFC
- bond volatility was at its highest since 2015
- Sentiment was not helped by escalating tensions between Saudi Arabia and Russia
- oil prices and related stocks plunging
- initially fell to $26 a barrel; a fall of more than -67% from January levels with the WTI oil price even hitting negative territory in April
- Government bonds rallied as yields fell dramatically when central banks slashed interest rates
- extraordinary fiscal measures and investors flocking to safe-haven assets
- corporate bond yields rose across all regions and credit ratings
- April saw relative calm with virus data beginning to show some green shoots of improvement in many counties, although numerous challenges still lie ahead
- many equity markets recovered some of the losses incurred in March with the S&P 500 leading the way
- this period of extreme volatility and uncertainty has been very unsettling for clients, but has also presented attractive long-term investment opportunities in our view
- T&IO will provide further details on how these opportunities have been implemented shortly
It is safe to say that the first few months of 2020 will be etched in everyone’s minds for many years to come. The Coronavirus pandemic has had a profound effect on many aspects of everyday life and will continue to do so.
The widespread and indiscriminate selling of financial assets, from the end of February through the middle of March created huge challenges for multi asset portfolios, even those as diversified as PruFunds. This was evidenced by the mid-quarter UPAs.
Within T&IO it was important to remain calm and vigilant but also fully operational. With the technology already in place to support working from home, teams were able to function effectively as soon as the lockdown was announced. As many advisory businesses have also found, modern technology provides a quick and efficient means to communicate even in the most challenging times.
So, what happened?
The start to the year was relatively calm.
Before the gravity of the Coronavirus situation became apparent developed market equities were broadly flat, and Asia and emerging markets slightly down. Safe-haven assets such as gold and developed market government bonds began to respond during the first 6 weeks of the year. In our view, this reflected some investors possibly preparing for a possible Coronavirus-led global slowdown or simply reducing risk to reflect the length of the economic cycle.
Towards the end of February, the reality hit that a potential human tragedy was unfolding which would dramatically affect economic activity. Sentiment plummeted across markets as investors rushed to sell financial assets. The speed of the sell-off was notable, albeit off the back of strong performance in 2019, which had been driven by the hope of economic activity improving. What took several months during the GFC happened in a matter of weeks this time round.
Equity markets became highly sensitive to case news. There were rallies on the back of a fall in new cases in Italy and falls when US cases took a marked upward step. US cases of COVID-19 rose from 150 to over 100,000 between 4 March and 27 March. In February alone, there were over 18 days where the S&P 500 was either up or down by more than 3%.
Corporate bond markets were also volatile as secondary markets and liquidity evaporated. Spreads on 1-year investment grade bonds jumped nearly 300bps in US and around 200bps in the UK and Europe. The moves in high yield were amplified with 1-year US high yield bonds spiking over 700bps and in the UK and Europe between 560/600bps. The US high yield segment was harder hit than Europe due to its larger weighting to energy companies, particularly shale producers.
Initial fears of a credit crunch have died down. The sheer scale and speed of central bank action has been unprecedented. The various bond buying programs have helped credit markets recover from their mid-March nadirs.
Foreign exchange markets were not spared the panic seen elsewhere and there was a lot of demand for the US dollar as investors rushed to US assets as safe havens. Sterling was particularly challenged.
Although Covid-19 continued to spread globally in April, some countries saw the rate of daily new infection rates start to fall. Governments now must grapple with the consequences of reopening their economies and balancing the difficult trade-off between economic risks and health risks.
The S&P 500 index returned 12.8% in April recovering 50% of this year’s decline, volatility fell, developed stock markets outperformed emerging markets, growth stocks outperformed value and fixed income markets rallied. The FTSE All-Share index underperformed most equity markets, due to the energy sector exposure and ended April up 4.9%. The main catalyst of the April rebound was the significant stimulus measures introduced by governments and central banks to contain the damage caused by the shutdown. Improving virus related data was also supportive.
There were still negative headlines as the WTI cure oil price reached negative territory for the first time in history amid rising inventories from falling demand, and a global storage space shortage.
Some comments on PruFund portfolios
This year has reminded us that no multi asset portfolio is immune to extreme falls in asset prices. The diversification within PruFunds, not just by asset class, but by region and through public and private markets has served policyholders well for many years and we believe will do so in the future.
Whilst we are unable to provide specific data on underlying performance, we thought it would be helpful to provide some insight and comments on the broader asset class exposures.
With assets under management of over £50bn, PruFunds have significant exposure to global equities. Individual holdings are primarily larger cap. stocks, with peripheral exposures to small caps. Clearly, these portfolios will have felt the full brunt of the market sell-off and some companies will inevitably face challenges in the weeks and months ahead.
In terms of actual concentration, in PruFund Growth portfolios, for example, there are over 400 individual positions in UK equities, the largest being c.0.5% of the overall portfolio. The largest single stock position in Asian equities is c0.6% and in the US c0.3%.
In our view, equity markets offer long-term opportunities for portfolios and will provide a further update on activity shortly.
Our managers see current volatility as a buying opportunity where valuation does not reflect fundamental value due to the broad market sell-off. In our opinion, they have a proven track-record of exploiting this helped by the allocation of long-term capital
The T&IO Manager Oversight team has consistently found the credit analyst teams of all underlying managers to be both well-resourced and of high quality. Times of stress and volatility are where we believe they can add real value to portfolios by avoiding many ‘problem credits’.
Similarly, to equities, PruFund portfolios have diversity by mandate but also within mandates. The UK and European fixed income mandates have in excess of 1,000 individual positions with the largest making up less than 0.1% of the fund. Over recent years, T&IO have gradually added regional diversification with the addition of Asian bonds and latterly a small holding in African debt.
There has also been a gradual increase into a diversified set of private credit assets. M&G have the benefit of an in-house restructuring team which T&IO access through work on private deals. This team is also on hand to help assess, re-underwrite and if needed potentially re-structure ‘problem credits’ in times of market stress if required.
The philosophy within T&IO has been to favour corporate bonds over government debt. This remains unchanged, although portfolios do still hold small allocations to US treasuries.
Limited transactions are still making the valuation of property difficult, reflected in the valuers’ recent statement of ‘material valuation uncertainty’.
The full impact is still to feed through but sectors such as Retail, Leisure and Offices are going to be affected, as well as Industrials as economic activity slows. At the same time, Supermarkets will be holding up well, as will Distribution Warehouses as people rely more on online shopping.
The diversification of property holdings into international markets is a positive. The segregated mandates for Growth and Cautious are typically core/prime in nature, so if there is a sell-off in certain sectors or geographies they should not be affected to the same extent as the wider market.
Rental income (particularly Retail) will be tested, although government support will shelter many companies from business rates and staff wages. Our managers continually look at the ability of tenants to pay rent as part of the ongoing management of assets. Rent deferrals are possible in some cases and these will be assessed on an ongoing basis.
PruFund portfolios have invested in property for a long time and the asset class has generated strong risk adjusted returns. There will be downward pressure on valuations in some sectors over the next few months however we remain committed to the asset class.
Alternatives exposure within PruFund is primarily through private funds. We would expect alternatives to be impacted by the negative environment, although most assets are valued quarterly so the avoid intraday/intraweek volatility of comparable listed companies. Some investments within the alternatives portfolio are less exposed to highly cyclical sectors and more focused on structural trends, for example infrastructure opportunities. Many of these businesses continue to provide essential services to their communities. Where assets are under construction these may see delays but are expected to be fulfilled.
There are other areas like insurance linked securities and music royalties, for example, that will likely be less affected.
Our managers remain patient and will hold positions that will see recoveries in relative returns as markets correct, whilst also rotating into opportunities that we identify.
Strategic asset allocation changes
As 2020 has progressed there are areas where we see long-term value. Having identified these opportunities, T&IO is hard at work in moving both PruFund Growth and PruFund Cautious towards new strategic asset allocation benchmarks.
A further update will be provided towards the end of May.
It would be impossible for anyone to say with any certainty, where next?
The global economy is in the most severe contraction since the Great Depression. The International Monetary Fund’s latest forecast say the US, eurozone and Japan economies will register contractions of nearly 6%, 7% and 5% this year, respectively. The damage could have been worse without the unprecedented fiscal and monetary stimulus. Most survey measures have reached historical lows as would be expected and some consequences from lockdown have yet to be fully visible in low frequency data.
The virus statistics are key from here. Markets have been bombarded with more stimulus than during the GFC, but then much of the macro-economic data and economist projections are also worse than at that time. With statistics improving in several European countries there is now a focus on predicting the speed of reopening and thus the likely shape and timing of the potential recovery.
There is no question that, whilst there is ‘light at the end of the tunnel’ we are some way from returning to normal and for many companies the pandemic will change what ‘normal’ is forever. The lockdown has had many negative consequences but has also brought into even sharper focus issues like carbon emissions and climate change which can only be a good thing for the environment. Many businesses will have seen their carbon emissions fall even sharper than equity markets in March.
T&IO remains fully focused on adhering to the long-standing investment philosophy and processes that have worked well for many years. The team has no greater insight into the future than anyone else but has concentrated on what can be controlled, which is how we invest both now and in the future.