Developed equity markets have surprised many by the strength of the rally since late March. Senior investment strategist Daniel Morris discusses the outlook and the opportunities with Guy Davies, chief investment officer active equity strategies.
Do you think the optimists will triumph in equities this year?
Guy: I am an optimist by nature and there are reasons to be optimistic for equities. However, in our view, it would be wrong to extrapolate recent market trends and particularly the recent strength in equity prices.
Perhaps contrary to the popular view, the swiftest rallies often occur in bear markets. Such a rally can gather momentum through the phenomenon of ‘fear of missing out’ (FOMO) where buying begets buying.
The falls in prices and indices across equity markets (see exhibit 1) had been such that bargain hunters abounded in the second half of March. The more important question is whether prices were cheap enough to offset the social and economic impact of the virus. That impact will be a multi-year event.
What I do know is that some companies will not survive, some will come through with considerable change and remodelling, and others will emerge winners. The role of my teams – within equity markets – is to identify those winners and I am optimistic and confident about our ability to do so.
How has performance been during this very challenging period?
Guy: Looking across the board, I would say so far so good: our equity strategies have, largely, delivered strong performance relative to their respective benchmarks.
- Emerging markets and China: Such strategies have performed well, thanks to an overweight in commodities and underweight in key sectors and countries in the former. We have worked on this position over the last 12 months and we expect it to continue to generate strong performance.
- US: Our exposure generated strong relative returns, with absolute performance rebounding and leading other developed markets.
- Small caps: Stock selection has been positive and our thematic strategies have proven resilient relative to the broader market.
- Large caps: Stock selection and positioning for larger companies has proven positive – the quality and resilience of our holdings has been recognised by the market and rewarded.
- Global: Within the unconstrained strategies, our stock selection and relative numbers have been positive.
What are the key principles that have guided your approach?
Guy: Firstly, we have a strong team with experienced investors. The last weeks have been extreme, but we are no strangers to market volatility. Like many on the team, I worked through the Asia crisis in the 1990s, the dot-com bubble and the Global Financial Crisis. Some of our senior portfolio managers were managing assets on 1987’s Black Monday. So between us, we have seen some challenging times.
Let me outline our key principles:
- Stick to the script – over the years, we’ve honed our approaches to focus our attention on the factors that we believe drive stock prices and on our demonstrable strengths. The objective is to maintain the forensic focus on the factors that move the dial.
- Be alive to opportunities – volatility in prices offers opportunities to trim some positions and incept others. In recent weeks, we have focused on improving our portfolios from the perspectives of both return and liquidity.
- We manage high-conviction portfolios with a high active share, with ‘relative’ risk increasing at the margin in recent weeks.
What trends do you expect to influence sector allocation?
Guy: This is one of the key questions for us. Share prices ultimately reflect earnings, so our portfolio positioning is based on a relative assessment of earnings and earnings growth. Our sector allocation reflects those stock discussions and decisions.
Currently, we are focused on several overarching themes:
- Corporate disruption: The various ways in which the pandemic will create new sources of disruption or amplify existing disruptive trends in the corporate sector. For example:
- The shift to teleworking/agile working – to the benefit of companies offering best-in-class solutions in technology and logistics; at the expense of transport and commercial property
- In healthcare – over the medium term, supporting the fight against COVID-19. In the long run, we are likely to see higher spending as a percentage of GDP on healthcare. In addition, national security requirements will argue for producing key equipment domestically.
- De-globalisation: A transition from global to local supply chains as a greater share of the production process takes place closer to the final consumer. This stands to benefit companies with local suppliers. It, also leaves the ‘in China for China’ strategy intact, anticipating an economy more reliant on internal consumption.
- Sustainability: How the crisis may prompt behaviour – of both the private sector and policymakers – towards more sustainable outcomes:
- Private sector: A groundswell of demand for action on inequality and air quality (the virus having made the benefits of this apparent)
- Public sector: Stimulus and support measures linked to green projects.
- Corporate strength and industry structure: How the crisis may lead to an economy with fewer companies, potentially enjoying greater pricing power. Some companies will fail, others will be financially constrained such that they cannot contest new or existing markets.
- Consumers: How attitudes to leisure, travel, consumer staples and safety will evolve. They are likely to be more cautious and constrained.
It is an extraordinary time to be investing for our futures. Our experienced team has demonstrated its ability to build robust portfolios capable of withstanding shocks or negative events, as we did in the downturn this year. I am confident we can now position our portfolios to take advantage of the opportunities that will arise.