Investment Review - Quarter 2 2020

Investment Review – Quarter 2 2020

Following the significant falls in global equity markets during the majority of the first quarter, the rally seen towards the end of March continued into the second quarter, leading to a significant rebound overall, albeit with continued heightened volatility. Central banks and governments globally moved to support economies through unprecedented levels of monetary and fiscal policy intervention, plus social restrictions were gradually relaxed towards the end of the quarter. Investors tried to look through the very short-term economic impact of the ongoing coronavirus crisis towards some form of economic recovery.

Equities

Having underperformed by a large margin in Q1, the main UK equity market was again a major underperformer in both sterling and local currency terms. It did produce a double-digit return but remains very negative for the year to date and significantly behind the other major markets. Once again, the US market led the way, rising over 20% in sterling and dollar terms and, in contrast to the UK, is in positive territory for 2020. Europe, Asia and emerging markets performed strongly with returns enhanced in sterling terms due to the relative currency movements. Australia was a strong performer within the Asia Pacific region. Within emerging markets there were no significant differences between the main sub-regions of Latin America, Europe and Asia. Japan produced a double-digit return but, like the UK, this was significantly behind the other major markets, although it had fallen much less in Q1 leading to better year to date performance.

Fixed Income

Fixed income saw a reversal of the previous quarter’s relative performance with high yield, emerging market debt and investment grade bonds producing strong returns and significantly outperforming conventional government bonds. UK and global government bonds were positive but there were stronger returns from index/inflation-linked bonds despite the large drop in short-term inflation. Longer-dated UK conventional and index-linked gilts outperformed their shorter-dated counterparts. The performance of currency hedged assets was negatively impacted by the relative movements of sterling.

Other Assets

In other asset classes, UK commercial property returns were again marginally negative, influenced by ongoing difficulties in the retail sector, and also by the broader economic impact of the coronavirus on other sectors, such as leisure and hotels. Globally, property securities performance was very positive, mainly benefiting from the gains in equity markets with Asia and the US the strongest performers. After falling significantly in Q1, the oil price rose over the second quarter as a whole, but this was after further significant falls in the first few weeks of the quarter due to ongoing global demand concerns and lack of reaction to supply from oil producers. The gold price saw another double-digit rise, but it was significantly outperformed by the rise in the silver price.

Property Fund Suspensions

Property funds continue to be suspended, having been gated since 18th March 2020. All physical property funds have been forced into this position because commercial property valuers have declared a ‘material uncertainty’ about the value of the properties held within them, reflecting the unprecedented ramifications of the global Covid-19 outbreak.

Model Portfolio Performance

This continues to be a difficult environment to negotiate, however this quarter we have seen a significant recovery in the portfolios ranging from 9.02% in portfolio 3 to 15.11% in portfolio 7. We should not get too enthused by this, as over six months the returns still range from being marginally negative to marginally positive. Given the depth of the crisis created by coronavirus we cannot assume we are now on a pain free path to positive returns. There will many more twists and turns to negotiate on the way to a full removal of the lockdown restrictions. Not all industries and sectors have fared the same, and stock market returns have been boosted by significant government and central bank intervention. What happens as this support is removed is still a concern and we remain cautious in the short term, and expect continued volatility to occur as sentiment fluctuates on news flow.

Table 1. Summary of Q2 Model Portfolio Performance

Model PortfolioQuarter 1 2020 PerformanceBenchmark Performance
Three+9.02%+5.84%
Four+10.70%+7.15%
Five+12.06%+8.43%
Six+13.47%+9.81%
Seven+15.11%+10.97%

The recovery in quarter two has been almost as dramatic as the falls in quarter one, as most assets have delivered positive returns, the only exception being property. The strongest of the returns have been in risk assets which have taken confidence in the support given by central banks and governments to deliver packages that, although significantly increasing debt to GDP ratios and debt issuance, have provided an underpin to the global economy.

Model Portfolio 3

The portfolio has had a strong absolute and relative quarter with a number of funds contributing significantly to the returns versus the benchmark. The majority of the out-performance has come from the equity assets although all funds with the exception of property and cash have contributed to the total return. Two of the regional funds, JPM Japan and Blackrock European Dynamic, have both returned over 25% in the quarter. Blackrock has benefitted from avoiding cyclical sectors such as banks and has had a higher mid cap weighting. JPM Japan has benefitted from the concentrated growth bias of its stock selection.

In fixed interest, spreads have tightened after the initial shocks in quarter one and credit has seen the strongest returns with high yield the best performing asset class. More defensive funds such as Invesco Corporate Bond have had weaker relative quarters for this reason. Overseas holdings have had the edge over UK-based funds as sterling has remained weak against other currencies such as the dollar and the euro. Property has been the only area with a negative return as valuations have downgraded retail and leisure properties and rental income has come under pressure. The holding in infrastructure has however offset this.

Model Portfolio 4

We saw a surprising level of asset price recovery over the quarter and the portfolio continued to outperform its benchmark and delivered solid absolute returns. The main reasons for the level of return were firstly a renewed level of confidence in the easing of lockdown in the developed world, and secondly a view that risk assets were oversold and needed to rebalance. In equity the strongest returns came from the European and Asian markets. The JPM Japan and Blackrock European Dynamic funds returned over 25% and were helped by a small allocation to the Merian UK Mid Cap fund which was up over 30%. Mid and small cap stocks recovered more dramatically having fallen further in the downturn.

Fixed interest assets were also positive contributors and the funds with higher levels of credit and high yield holdings delivered the best returns. Overseas holdings have had the edge over UK based funds as sterling has remained weak against other currencies such as the dollar and the euro. Property has been the only area with a negative return as valuations have downgraded retail and leisure properties and rental income has come under pressure. The holding in infrastructure has however offset this.

Model Portfolio 5

There has been a significant turnaround in the fortunes of risk assets this quarter although markets are not back up to pre-crisis levels, with the exception of specific sectors such as technology and healthcare. As would be expected given the improvement in sentiment backed by government support, the risk assets in the portfolios, i.e. the equity funds, have been the cornerstone of these improved returns. The best returns have come from the European and Asian funds, with solid returns from the core UK funds. The highest returns in the UK have been in mid and smaller companies as they have recovered more strongly and this is seen in the Merian UK Mid Cap fund with a 30% return.

Fixed interest assets were also positive contributors and the funds with higher levels of credit and high yield holdings delivered the best returns. Overseas holdings have had the edge over UK based funds as sterling has remained weak against other currencies such as the dollar and the euro. Property has been the only area with a negative return as valuations have downgraded retail and leisure properties and rental income has come under pressure. The holding in infrastructure has however offset this.

Model Portfolio 6

The improvement in stock market returns around the globe has been significant but this shouldn’t be confused with the more fragile state of the global economy. In the portfolio returns from all regions have been good, particularly in European and Asian funds. The JPM Emerging Market fund and the Blackrock European Dynamic funds have both shown sector leading performance with 25% returns. In the UK we have seen the Merian UK Mid Cap fund return over 30% as small and mid-cap areas of the market recovered strongly. The JOHCM UK Dynamic fund with its more value-based focus has been the weakest UK fund but has still been a positive contributor overall.

Fixed interest assets also provided positive contributions with the funds with higher levels of credit and high yield holdings delivering the best returns. Overseas holdings have had the edge over UK based funds as sterling has remained weak against other currencies such as the dollar and the euro. Property has been the only area with a negative return as valuations have downgraded retail and leisure properties and rental income has come under pressure. The holding in infrastructure has however offset this.

Model Portfolio 7

The returns this quarter have been predominantly from overseas equities, with one exception in the UK being the Merian UK Mid Cap fund which returned just over 30%. The recovery in global stock markets was greater than expected after the significant falls in March and it was those areas that fell the most such as emerging markets that saw the largest recovery. In the portfolio returns from all regions have been good, particularly from the European and Asian funds. The JPM Emerging Market fund and the Blackrock European Dynamic funds have both shown sector leading performance with 25% returns. The JOHCM UK Dynamic fund with its more value-based focus has been the weakest UK fund but has still been a positive contributor overall.

Fixed interest assets were also positive contributors and the funds with higher levels of credit and high yield holdings delivered the best returns. Property has been the only area with a negative return as valuations have downgraded retail and leisure properties and rental income has come under pressure. The holding in infrastructure has however offset this.

Summary

The economic and social impact of the coronavirus has been significant with the worst economic data, reflecting activity in the second quarter, yet to come. However, markets are generally forward-looking and most of the negative impact has already been reflected in equity market prices, particularly during the downturn in the first quarter. The rally started towards the end of the first quarter, after the initial flood of coronavirus-related news, had started to slow. The question now is whether markets have been too optimistic.

The reaction of global central banks and governments has been to do whatever is necessary to stabilise the current situation, to support economies as much as they can, support sectors and companies in difficulty and to support consumers/workers in the short-term. This is in addition to what was already a supportive monetary policy environment with low interest rates and contained inflation. Whether these extreme policies can do any more than simply stabilise the current situation remains to be seen and certain government support will be reduced or removed at some point (e.g. the UK’s Job Retention scheme).

The future direction of equity markets and other asset classes is very difficult to determine with any accuracy due to the degree of uncertainty. Furthermore, from a UK and European perspective, Brexit, seemingly a forgotten issue, is likely to rear its head again in coming months, as the end of June deadline for an extension has been and gone, which means the UK will leave the EU on the 31st December with or without a deal.

Headline equity market valuations look relatively expensive and it is difficult to argue that equities look attractive on an absolute basis due to the significant falls in forecast corporate earnings. On a relative basis, however, equities are still our favoured asset class and one of the few areas where you can expect to generate any form of meaningful return over the medium to long-term. The level of government and central bank support remains significant, providing liquidity that needs to find a home, and with the unattractive rates on cash and fixed income yields at historic lows, the home is likely to be in equity markets.

Nothing in this article constitutes financial advice. If you’d like more information on anything covered in this article or want to speak to one of our advisers for advice tailored to your circumstances, please head over to the Contact Us section to book your free, no obligation consultation.

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Sam Secomb
ssecomb@pentinsfp.co.uk

Chartered Financial Planner and Managing DirectorSamantha Secomb joined Pentins as their Chartered Financial Planner 2015 and is now a shareholder and director of the business.Samantha is a Fellow of the Personal Finance Society which is widely accepted as the premier qualification standard for advisers in this country. Having reached the top in her professional qualifications she is currently studying with Warwick Business School for her Master’s in Business Administration (MBA).

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