As global stock markets dive in the face of the Covid-19 pandemic, charity investors may be wondering what they should be doing with their portfolios, if anything. We believe it makes sense for those with suitable risk tolerance and a decent time horizon to consider wading cautiously into markets.
No doubt, this has been a terrible economic jolt which has made many people ill with fear. Not just about their health and their financial security, but about the potential for the whole financial system to come apart at the seams. But hopefully, it will be some comfort for you to know that we see this as a fringe outcome and we think there is some value on offer for your charity portfolios.
It may not feel like this, but financial crises are actually relatively rare events and the risk of the current market correction evolving into a crisis is low. About 150 years of history suggests crises have common precursors. They tend to be preceded by an extraordinarily rapid increase in leverage, of a speed that we have not seen over the past decade, often as a result of financial de-regulation (quite the opposite to today) and an overextension of credit to un-creditworthy borrowers as a result of imprudent lending standards, especially by weak banks with inadequate capital (again no systemic evidence of that today). This is so important for our decision to start buying into the drop because without a financial crisis economic recoveries tend to be V-shaped - a relatively quick rebound.
To stave off recession, or at least to minimise it to two quarters, firms need monetary easing to offset some of the financial tightening caused by higher bond yields. They also need targeted monetary policy in addition to cutting interest rates. If fiscal and monetary policy does begin to arrest the tightening of financial conditions, and firms don’t start to position for a protracted crisis, at that point we believe it would be sensible to take on greater exposure to stock markets. But this is also conditional on the spread of the pandemic. If the transmission and morbidity profile worsens, and/or adequate stimulus fails to get passed, it may make sense to reduce equity exposure, depending on where valuations are at the time, because the risk of a prolonged recession would have increased.
Financial risks remain
All of this is not to say that there are not risks to the financial system, risks that may make the economic fallout greater than it would otherwise have been. We are concerned about the liquidity and quality of corporate bonds, an area that has come under particular pressure during this correction.
We are concerned that the turmoil in the bond market may induce fire sales of good assets, particularly considering the unprecedented role of bond exchange-traded funds (ETFs) in today’s markets. Historically low interest rates have precipitated an unprecedented hunt for yield, which encouraged many ‘tourist’ investors into corporate bonds in general, and passive ETFs in particular. ETFs offer instant liquidity to investors, yet the fixed income assets within them are relatively harder to sell, creating a liquidity mismatch that is straining the sector.
A plan, but not a crystal ball
Equity markets have a tendency to overshoot and there may be even better entry points presented tomorrow. However, we don’t have a crystal ball. We can’t know what will happen in a few days or a few months.
But we are long-term investors. We asked ourselves, “would we regret missing an opportunity at these levels in two years’ time?” The answer, given the information in front of us, was yes. Unless we believe that the world will definitely enter a recession in 2020 and that 2021 will not follow a V-shape but an L (as a result of a financial crisis, perhaps), today looks a good entry point to realise long-term value. Acting now makes sense.
Andrew Pitt is head of charities at Rathbone Investment Management, which has a knowledge and insight hub on its website.
This content has been supplied by a commercial partner. Rathbone Investment Management is the overall partner for the Charity Awards.
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