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FOR PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY NOT TO BE REPRODUCED WITHOUT PRIOR WRITTEN APPROVAL PLEASE REFER TO ALL RISK DISCLOSURES AT THE BACK OF THIS DOCUMENT
MULTI-ASSET MONTHLY
Insight Broad Opportunities Fund (IBOF, GBP) March and Q1 2020
SUMMARY
Q1 was a catastrophic quarter for risk assets in which the
spread of COVID-19 led to large parts of the global economy
essentially being shut down, with individuals in all but
essential jobs being confined to their homes across many
regions. As the response to the virus became the main focus,
and the economic impact of the quarantines became clear, a
prolonged U-shaped recovery became far more likely than
the quick V-shape that many had previously hoped for.
Governments and central banks reacted with massive
support packages for household and corporate income but
the market response has been equally historic. Equity
markets have borne the brunt of the sell-off. While the
drawdowns in the major equity markets (c.-30% to -35%) is not
unusual in bear markets, the speed of the decline (less than a
month) is without precedent going back to, and including,
the great depression.
Against this extreme market backdrop the strategy gave
back 12.28% in the first quarter, taking our 1-year and 3-year
returns to -5.15% and 0.28% p.a. respectively.
Fund performance as at end March 2020
1 month return
%
3 month return
%
1 year return
%
3 year return % p.a.
5 year return % p.a.
Insight Broad Opportunities Fund
-8.06 -12.28 -5.15 0.28 0.53
3-month GBP LIBID
0.03 0.14 0.63 0.53 0.47
Table 1: Fund performance as per calendar year
YTD
% 2019
% 2018
% 2017
% 2016
% 2015
%
Insight Broad Opportunities Fund
-12.28 13.13 -4.99 10.13 5.05 -1.19
3-month GBP LIBID
0.14 0.68 0.60 0.24 0.38 0.45
Data sourced from Lipper. Returns are in GBP, gross of annual management charge and net of irrecoverable withholding tax, and are not grossed up for charges applied to underlying unitised holdings. Fund inception date: 30 September 2009.
Figure 1: Daily change in coronavirus cases versus the MSCI World equity index
Source: Insight. Data as at 1 April 2020.
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Italy: cases, 000s, lhs
Spain: cases, 000s, lhs
UK: cases, 000s, lhs
US: cases, 000s, lhs
MSCI world equity: index, rhs
2 of 15
ECONOMIC AND MARKET REVIEW
The first quarter of 2020 was one of the most difficult for
financial markets in living memory. A decent start, with key
numbers pointing to a stabilisation in global activity – after the
trials and tribulations of the US-China trade war – was followed
by the surprise arrival of COVID-19, and the introduction of what
seemed, at the time, like fairly shocking lockdown measures in
Hubei. Although talk of SARS and MERS quickly emerged,
financial markets were initially fairly relaxed about this – seeing
the closing off of Hubei as a positive, rather than a negative.
There were little flurries of concern as ‘super-spreaders’ were
identified – individuals who had carried the virus to Europe and
beyond. But that changed when the impact of the virus and the
broader lockdown across China on its economy was revealed,
and rapid rates of infection in other countries were announced.
With death rates surprisingly high, emergency measures were
introduced in all of the affected countries. But only South Korea
put widespread significant testing and control measures in place
immediately. That had large repercussions, with infection
spiralling dramatically in Italy and Spain – then in the UK and the
US. By the end of the quarter, most Western governments
realised strict quarantine rules were needed, and these were
rapidly introduced. Fortunately, it was also realised that a
quarantined population/business sector would need a huge
amount of financial support in order to prevent an economic
catastrophe.
Massive relief packages, aimed at supporting household and
company incomes, were announced – with more promised
should that prove necessary. In our view, most governments
should be applauded for the scale of the response (if not its
timing). Central banks joined in with surprise rate cuts, and a
wide range of further support/quantitative easing measures.
Although financial markets have been encouraged by these
moves, the position of key Western economies on the ‘epidemic
curve’ means they coincided with some horrific virus numbers –
numbers that will probably get a lot worse before they get
better. Against that dystopian background, risk assets suffered
terribly. The MSCI World Index and S&P 500 Index fell -34.2% and
-33.9% at their worst point, with the MSCI World Index down
21.4% over the quarter. Commodity prices fell 42%, with oil down
65%. Key bond yields fell dramatically in line with rate cuts and
the deteriorating outlook (overwhelming the impact of the huge
supply increases implied by the support packages). The 10-year
US Treasury yield fell 122bp in the quarter. As is usual in times of
crisis, the dollar and yen both strengthened in the quarter.
Figure 2: One month moves (volatility adjusted)
Figure 3: Three month moves (volatility adjusted)
Source: Bloomberg and Insight. Data as at 31 March 2020.The price movement of each asset is shown next to its name. The data used by the bar chart divides the price movement by the annualised historical volatility of each asset.
-6 -4 -2 0 2 4
VIX 2m TR: +78%
V2X 3m TR: +58%
UST 10y Future (TR): +3%
USD (trade weighted): +1%
Gilt Future: +1%
Kospi 200 Future: -12%
S&P 500 Future: -13%
EUR Main (5yr, ER): -1%
CDX IG (5yr, ER): -2%
FTSE 100 Future: -14%
US High Yield: -10%
ESTX 50 Future: -17%
MSCI EM Future: -16%
Euro High Yield: -14%
EMD (Local): -12%
Oil (Brent): -55%
FTSE 100 Divs (21s): -49%
Nikkei Divs (21s): -29%
EMD (USD): -15%
ESTX50 Divs (21s): -55%
-4 -2 0 2 4
VIX 2m TR: +146%
V2X 3m TR: +137%
UST 10y Future (TR): +8%
Gilt Future: +4%
USD (trade weighted): +3%
H Shares Future: -14%
Kospi 200 Future: -20%
S&P 500 Future: -20%
CDX IG (5yr, ER): -3%
EUR Main (5yr, ER): -2%
ESTX 50 Future: -26%
FTSE 100 Future: -25%
Euro High Yield: -17%
MSCI EM Future: -25%
EMD (Local): -15%
FTSE 100 Divs (21s): -52%
Oil (Brent): -66%
EMD (USD): -16%
Nikkei Divs (21s): -33%
ESTX50 Divs (21s): -58%
3 of 15
ECONOMIC AND MARKET REVIEW (CONTINUED)
From a monetary policy perspective, the objective of
quantitative easing and the other actions announced is to ensure
that there are no seizures within the financial system as we saw
in the global financial crisis (GFC). At the same time, these
measures are likely to keep bond yields low or lower, at least in
the short term, irrespective of the fiscal pledges that
governments are announcing.
From a fiscal policy perspective, the scale of the support
measures announced is unprecedented – both in size and scope.
The UK, for example, has introduced a job retention scheme,
under which the government will pay up to 80% of a worker’s
wages. This is limited to £2,500 per month and will initially run
for three months, but will be extended should that prove
necessary. Means-tested benefits and tax credits will be
increased by £20 a week for one year. Renters are to be given an
extra £1bn in housing benefit. Evictions are banned for three
months. Mortgage holidays have been introduced.
Businesses are to be helped by a deferral of VAT and income tax
falling due over the next few months. The self-employed will be
able to claim a taxable grant worth 80% of trading profits (up to a
maximum of £2,500 per month for the next three months). Small
and medium sized businesses will be able to reclaim two weeks
of statutory sick pay for employees. For retail, leisure and
hospitality businesses, there will be a business rates holiday, and
they will also be eligible for grants of up to £25,000. Other grants
will be available, while larger companies will be able to borrow
up to £5m over six years (with measures to cover first-year set-
up costs and interest), of which the government will guarantee
up to 80%. Meanwhile, the Bank of England will buy short-term
debt of larger companies, and previously announced interest-
free loans will be interest-free for a longer period of 12 months.
The response has been different elsewhere. We will not give
such an exhaustive list of measures for these, as space and time
does not permit. In simple terms, the US has passed a $2.2tn
package – the largest emergency response in its history. Money
will be sent direct to all US adults, with amounts dependent on
income. Those who earn up to $75,000 will get a payment of
$1,200. Married couples earning up to $150,000 will receive
$2,400. Those with children will be paid a further $500 per child.
Beyond that, payments are steadily reduced. Those with an
income of $99,000 ($198,000 for couples) will get nothing. There
is also a $500bn lending programme for businesses, cities and
states, and a $367bn fund for small businesses. $130bn has
been set aside to help hospitals and to raise unemployment
benefit.
In France, the government has announced a €45bn package of
tax breaks and direct state payments. €8.5bn of this will paid to
workers who have been laid off because of the virus. The
government has also announced a €300bn state-guaranteed
loan package. Nationalisation might also be considered.
Spain has announced a similar state-guaranteed loan package of
€100bn for the corporate sector, and has committed to
providing all the liquidity businesses need. Mortgage payments
and utility bills have been deferred. The government has also
allocated €600m to increased social benefits.
The German government introduced a €750bn package. €50bn
will be used to help the self-employed and very small businesses
(via grants and loans). Unemployment benefits will be available
for freelancers. A further €10bn will be made available for
housing costs over the next six months. (Note: Germany already
has a ‘short-time working’ system where companies can reduce
hours rather than employees, and the government makes up
some of the lost income.) Evictions will be prevented. There will
also be loan and tax deferrals. €600bn will be available in various
forms for large businesses. Nationalisation is, again, a possibility.
The aim of these policies is clear. The coronavirus represents an
economic shock unlike any we have seen in the post-war era,
and history suggests the chances of a quick recovery will
decrease markedly if second or third-round effects from
sustained rises in unemployment and/or large-scale business
failures are allowed to exacerbate the impact of the mass
lockdowns being put in place to contain the virus.
Figure 4: Estimate of fiscal impact from policies to address effect of COVID19
4 of 15
Q1 Review
Clearly this has been a challenging environment. After a strong
start to the year, our risk-management disciplines helped to
contain losses, but against the extremely stressed backdrop, the
portfolio ended the quarter down 12.28%.
The primary driver of performance was the total return
strategies component. Price action in the European dividend
futures market was worse than during the GFC. As the crisis got
worse and companies indicated dividends could be at risk of
being omitted, dividend futures started to underperform.
Despite going into the quarter with relatively low exposure and
completely exiting these positions during the period, the scale of
the move resulted in this being one of the larger detractors from
performance. Losses were also incurred in range-bound and
breakout strategies where the extreme price action saw a
number of trades move through the embedded protection
buffers. These losses were partially offset by strong returns from
a range of defensive relative value trades, in currencies
(JPY/AUD, CHF/AUD and USD/MXN), equities (US vs Europe), and
fixed income (US and UK 30-year/10-year curve flatteners).
Our infrastructure investments have shown greater equity
volatility than has occurred in previous market corrections. As
markets became seriously distressed, despite their low
underlying economic sensitivity, there was a widespread
liquidity squeeze and these holdings took significant mark-to-
market pain. As of early April, a bounce-back looks to be
underway.
Against the scale of the moves, the losses from the riskier parts
of the strategy’s fixed income component (emerging market
debt and high yield) and the equity component were relatively
contained. This was largely as a result of the risk reduction
activity taken in these components over the past six weeks. In
addition, our government bond exposure was relatively high
going into this crisis and acted as a reasonable diversifier.
March Review
We finished the quarter with a negative return of –8.06% in
March. The ongoing spread of the virus, and efforts to contain it,
resulted in extreme stress in markets. The main negative
contributors were dividend futures exposures, and positions
designed for range-trading environments. Emerging market debt
and infrastructure holdings were also large detractors. Relative-
value trades (particularly in currencies) were positive, as were
government bond exposures, but these were not sufficient to
offset the losses elsewhere.
Figure 5: Performance of the Insight broad opportunities strategy (GBP) since launch
Source: Insight Investment. As at 31 March 2020. Gross returns. Performance rebased as at 31 December 2004, as a result of a change in investment team leadership. The performance shown is the long-term track record of Insight’s overall multi-asset strategy and is intended to illustrate the team’s capabilities. The performance of the Insight Broad Opportunities Fund, which launched on 7 September 2009, may differ. The long-term track record of the Insight broad opportunities strategy has a base currency of USD. This has been adjusted by interest rate differentials to derive a GBP proxy. No currency adjustments have been made to the underlying investments.
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PORTFOLIO PERFORMANCE
5 of 15
PORTFOLIO ACTIVITY
Q1 Review
Efforts to contain the spread of coronavirus will have a
significant impact on global growth and corporate profits. We
have made significant changes to portfolio positioning over the
quarter given the sudden change to the investment outlook. One
aspect of our activity has been to reduce risk exposures (by
asset class, and individual positions within total return
strategies) following our risk-management protocols designed to
contain losses in stressed periods. The other aspect of our
activity has been to introduce new positions that we believe are
well suited to generate returns going forward, especially option-
based trades within total return strategies where elevated
volatility and skew is offering attractive opportunities for a
degree of upside participation with significant downside buffers,
or downside range-trading positions again with wide buffers.
This is consistent with how we tend to tilt more towards
alternative sources of return when the outlook for traditional risk
assets becomes more challenging.
Our initial focus was on managing the balance of risks, with
duration at five years coming into the quarter and reducing the
most volatile assets (equities, emerging market debt and high
yield credit). We have tactically increased exposure to our
favoured asset class in this environment, investment grade
credit, where central-bank buying programmes seem likely to
offer support.
We have not reduced our infrastructure holdings as we retain a
constructive view on the outlook for the underlying investments.
That said we did partially hedge this exposure with a short
position in the FTSE 250 Index future.
Volatility spikes, particularly of the extremity seen, and diverging
economic fortunes also throw up interesting opportunities. We
have added relative-value trades in equities, currencies and fixed
income.
The speed of the current bear market is without precedent; the
closest parallels being 1987 and the Great Depression and both
of those bear markets saw deeper drawdowns. The level of
uncertainty around what we describe in the outlook section is
likely to mean that volatility remains elevated for some time, so
we can be patient in terms of looking to capitalise on that
through new total return strategy positions – seeking
diversification in the range of positions we employ, timing and
expiry. We also recognise that we can see two-way price action
as we progress through bear markets, so we will retain a tactical
element to our asset allocation.
March Review
We were swift in further reducing broad asset class risk
exposures in March (equity, emerging market debt, high yield),
and tactically increasing cash holdings. There was a high level of
activity within the total return strategies component as our risk
disciplines ensured we contained option exposures in a rapidly
deteriorating environment.
We added defensive relative-value trades in currencies early in
March, and latterly increased investment grade credit after
spread widening and on support from announced central-bank
buying programmes.
Trades put on in the month
Trades expired/closed in the month
• Relative value: CHF vs AUD, USD vs MXN currency
• Increased investment grade credit
• Replaced equity futures with option structures
• Range-bound positions added for US, European, UK, Chinese
and Japanese equities
• Downside position on German equity market
• Reduced equity, high yield, emerging market debt exposure
• Partially hedged Infrastructure exposure
• Removed dividend futures exposure
• Delta-hedged range-bound and upside trades on US,
European, Asian and emerging equity markets
• Closed range-bound positions on UK and US equity markets,
USD vs CHF currencies
6 of 15
ECONOMIC OUTLOOK
The outlook section of last month’s document asked whether or
not individuals would continue to visit restaurants, cinemas,
shopping malls, etc. in the face of such a virulent disease with a
high death rate (COVID-19). To help answer that question –
which would make it easier to size any likely impact of the
coronavirus pandemic on GDP – we sourced new high-frequency
data. Some of these series are outlined in the charts below,
which show how the restaurant business, air travel and cinema
attendance have been affected by its spread across the world.
Figure 6: Global seated diners - annual change, percent
Source: OpenTable and Insight. Data as at 31 March 2020.
Of course, the decision on whether or not to consume these
services was ultimately taken out of the hands of individuals –
with a number of governments effectively shutting down large
parts of their economies – so value-added fell to zero, or very
close to it.
The charts are still useful for two reasons. First, they show the
extent of the declines and the speed at which they happened.
Second, and perhaps more important, updating these numbers
should give us useful lead indicators as to when activity starts to
level off, and eventually improve.
Figure 7: Selected airports - % of scheduled flights achieved
Source: Flight24.com and Insight. Data as at 31 March 2020.
Figure 8: Global weekly change in box office take - 4 wkma, %
Source: Box Office Mojo and Insight. Data as at 31 March 2020.
The extent of any coming slowdown has also been made clearer
by a number of data points that have been released over the last
few weeks. Most of these have come out of China, and most
point to a huge reduction in activity. The chart below shows
production, investment, car sales and freight traffic all plunging.
Figure 9: China investment, sales & production – ann. chge, %
Source: Bloomberg and Insight. Data as at 31 March 2020.
We know from simple chart relationships that when these
variables move sharply lower, GDP should do the same – see
Figure 10. The implication is obvious. We should expect Chinese
GDP growth to drop a huge amount over the coming months.
We’re usually fairly cautious when it comes to comparing
economic cycles, because every cycle has its idiosyncrasies.
GDP outturns might be similar, but causes and policy responses
may differ, as may the global situation before, during and after a
recession. With that in mind, comparisons between the paths of
key economic indicators of the type outlined above suggest
China is currently on a far worse course than it was at the
equivalent point during the GFC (see Figure 11).
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Passenger car sales: rhs
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ECONOMIC AND MARKET OUTLOOK
7 of 15
Figure 10: China freight traffic and GDP
Source: Bloomberg and Insight. Data as at 31 March 2020.
Figure 11: China volume of retail sales - annual change, %
Source: Thomson Reuters and Insight. Data as at 31 March 2020.
Figure 12: US activity during the Spanish flu outbreak
Source: ALFRED and Insight. Data as at 31 March 2020.
Indeed, a slowdown of the order of magnitude seen in US
activity during the 1917-1918 Spanish flu epidemic seems a
more likely path for China this time round. Notwithstanding the
vastly different nature of the respective economies – then and
now – this historical reference point is of interest.
Of course, as noted above, the speed and scale of policy support
looks impressive even compared to the GFC, but let’s shelve that
for a moment – we’ll come back to it shortly.
We also know that, where China leads, everyone else tends to
follow – be it with respect to virus spread or the path of key
economic metrics. Europe and the US are around five to seven
weeks behind China in terms of virus spread, etc, so we would
expect the economic numbers to follow with a similar lag.
Recent data out of Europe supports that.
Figure 13: Global consumer confidence indices/balances
Source: Bloomberg and Insight. Data as at 31 March 2020.
PMI balances released over the next few days will give a better
guide as to what is happening around the globe with respect to
activity. One point to note here is that readers shouldn’t be
fooled by any apparent relative strength in manufacturing. That’s
because the PMI indices will probably be pushed higher by a
lengthening of suppliers’ delivery times – usually a sign of a
tight/strong sector, but now the sign of significant supply-chain
issues. Readers should also remember that the PMIs compare
activity with the previous month, so they are likely to spike back
up at some point over the next few months as activity expands
from a very low base (this has already happened in China).
If that’s the bad news, then the good news is clearly the
magnitude and speed with which income support measures
have been put in place by governments around the world whose
citizens are under some form of quarantine. The size of these
packages dwarfs anything we’ve seen before during times of
economic stress. This should help limit any negative confidence
spiral that could result from the effects of the pandemic. The big
question here is whether or not the authorities can get the cash
to those who need it quickly enough. Cash which goes through
payroll/tax systems should come through in time – though
recipients may be used to larger amounts. Mortgage and
eviction holidays will help to protect homeowners and renters,
while the removal of certain corporate taxes and regulations
should help keep previously well run businesses afloat. But the
UK’s plan to pay support money to the self-employed in June is a
concern. How can people survive without income for that long?
Time will tell.
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8 of 15
So, put all of this together and what does it mean? Could we see
huge quarterly GDP reductions in the major economies over the
next few months? Well, ‘yes’ – and beyond the big quarterly
numbers, calendar-year growth numbers look set to show
significant declines.
A lot of uncertainty remains around the length of time the
extreme contagion measures (i.e. lockdowns) are likely to remain
in place. Health officials and politicians have cited periods
spanning a month or so out to beyond six months. Our base-
case estimates (assuming roughly three months of lockdown)
would suggest GDP contractions of say -5% in 2020 for the major
economies but the confidence we attach to such numbers is
relatively low.
What we know is that the hit to growth is going to be huge, and
the risks are probably to the downside. We also know
governments have put huge support measures in place, and that
quarantines should eventually work on the virus. Given that, it
seems likely activity will recover at some point.
There is unlikely to be a V-shaped recovery as previously
expected, and probably not a short U-shaped return to normal
either. The extent of the pandemic and the measures needed to
stop its spread suggest a more drawn out affair than previously
expected. A long-bottomed U-shape growth path, if you like,
with a bounce in activity towards the end of the year. One key
focus for us over this period will be in monitoring the virus
numbers – the change in the change of cases and deaths,
particularly after work re-starts – and high-frequency data of the
type outlined above. We will continue to do that in seeking to
ensure we are among the first to notice when any improvements
or, heaven forbid, any further downturns take hold.
MARKET OUTLOOK
So the Goldilocks economy of 'mini-cycles' within an extended
growth cycle fine-tuned by policymakers has been shattered by
COVID-19. As discussed above, the global economy has been
pushed into an unparalleled recession, the ferocity and depth of
which is likely to be historic, but is as yet unknown. Our high-
frequency data analysis should help us read the pulse of
economic change.
Of course, the market response has been equally historic. Equity
markets have borne the brunt of the sell-off so this is where we
begin and our first aim is to get some historical perspective.
While the drawdown (thus far) in the major equity markets
(c.-30% to -35%) is not unusual in bear markets, the speed of the
decline (less than a month) is without precedent going back to,
and including, the great depression.
We illustrate this in Figure 14. In attempting to chart our way
through the crisis we draw lessons from past bear markets. The
characteristics we have witnessed – in terms of drawdown,
volatility, ranges and recovery – when coupled with our
economic views above, serve as our asset-allocation guide.
Lessons from the bears
We have characterised our historical review by bear-market
severity. On our count, we have witnessed 13 bear markets
(defined as a fall in the S&P 500 Index in excess of 20%) since
1929. In all but one (1987), these coincided with recessions of
varying intensity. We define three bears:
• A 'normal' bear-market which involves -20 to -30% declines
• 'Big' bear markets – these involve -30 to -50% declines
• 'Mega' bear markets – which saw declines in excess of -50%
This is only one way of dissecting bear markets. Categorising
them by cause or economic regime is equally valid in drawing
lessons from the past. Looking at history from our perspective a
couple of observations become apparent.
The current equity market drawdown is on the cusp between a
'normal' bear market and that of a 'big' bear, as shown in Figure
15. In the case of the former they are relatively short-lived and
the hit to corporate earnings is modest. The recovery time
(through to previous peak) is also short and roughly
commensurate with the length of the drawdown.
Figure 14: Bear markets compared – S&P500 1929 – 2020
Source: Bloomberg and Insight. Data as at 31 March 2020.
9 of 15
Figure 15: A lurch into the economic contraction zone seems inevitable – how long will it last and can markets look through it?
Source: Bloomberg and Insight. Data as at 6 April 2020.
The duration of the 'big' bear markets (peak to trough) is not
dissimilar but the hit to the economy and corporate profitability
is much greater. Consequently, the recovery time is much longer
(roughly three times as long on average).
As noted earlier the likely hit to economic activity in this crisis is
c.-5% for calendar-year 2020, assuming a relatively short virus
containment period (three months). From a corporate earnings
perspective the hit is likely to be magnified. Operational and
financial leverage suggest a guide of at least five times the
economic hit but index composition can also have big impacts.
In Figure 16 we show current bottom-up scenarios we deem as
credible. They currently centre on an S&P 500 Index earnings-
per-share (EPS) decline in excess of -25% with Europe likely to
post a deeper decline.
EPS declines of that magnitude could certainly put us in the
scope of 'big bear' territory. The lesson of history is if the fallout
from the pandemic becomes entrenched (business failures occur
on a large scale or we see significant and sustained increases in
unemployment), then a swift recovery becomes much less likely.
This is why the extraordinary policy response is critical if a big
bear is to be avoided.
Were that to happen, the current ‘crisis’ would be rare for yet
another reason. The avoidance of a 'big bear' will require
valuation multiples to cushion the earnings hit as normally equity
markets end a bear market cheaper than they were at the start.
So, to avoid such a 'big bear', markets will have to buy into two
things: firstly that the virus can be defeated before the economic
damage becomes entrenched, and secondly that policy can
minimise the economic damage in the interim and therefore
avoid such hysteresis.
Figure 16: Path of S&P 500 EPS in 2020
Source: Bloomberg and Insight. Data as at 31 March 2020.
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Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14 Dec-16 Dec-18 Dec-20
S&P 500 EPS (Trailing 12m) Consensus (Average) Bear Case (Worst Esimate) Bull Case (Best Estimate)
Consensus
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Bull Case
(Best Estimate)
Bear Case
(Worst
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Q1 2020 -10% -8% -15%
Q2 2020 -65% -58% -123%
Q3 2020 -28% -19% -21%
Q4 2020 -3% -9% 27%
FY 2020 -26% -24% -33%
In Figure 17 we explore the periods of EPS contraction in more
detail. Our current guess of a c.-25% EPS hit is comparable with
some of the worst S&P 500 Index earnings declines ever seen.
The table shows the 12-month EPS decline along with the index
return and the price/earnings (P/E) ratio over that period. Only on
two occasions have we seen material positive index returns in
such periods – 1961 and 1991.
Figure 17: Stock market performances during periods of
sharp EPS declines (US equity market – 1948 -2020)
Source: Bloomberg and Insight. Data as at 31 March 2020.
In early 1961 valuation multiples rose as EPS declined 20%. But
this preceded a six-month bear market in1962 when the S&P 500
Index fell -27%. The second occurrence, in 1991, came after the
1990 bear market with the earnings decline extending into the
stock market recovery phase. This looks like a text-book end
bear market bounce – markets are forward-looking and by early
1991 there were again signs of economic recovery. Moreover,
the bear market of 1990 was not a 'big' one, lasting only four
months and was associated with only a very mild recession.
A ready-reckoner for uncertain times
The S&P 500 Index was trading on a P/E of 22x going into this
crisis based on trailing 12-month earnings. Estimates for 2020
were close to flat. Stock market declines thus far equate to an
earnings hit at the lower end of the -20% to -30% range that we
currently guess. Such a move could be interpreted as the
market’s initial reaction to take on board the current
uncertainties. Figure 18 provides something of a 'ready-reckoner
of where the S&P 500 Index might settle depending on various
assumptions of earnings and valuations (expressed in simple P/E
terms). Of course, there are many caveats, not least what
valuation multiple should the equity market trade at.
The long-run (10 to 30-year) average P/E on the S&P 500 Index is
relatively stable around 18 times. Taking a 1.5 standard
deviation band around that gives us a range, or broad valuation
corridor, of 14 to 22 times earnings, which we have blocked in
Figure 18.
Figure 18: S&P500 Index 'fair-value' based on P/E multiples
(incorporating a 22% index decline to 31 March 2020)
Source: Bloomberg and Insight. Data as at 31 March 2020.
Combining this valuation zone with a likely earnings hit gives us a
fair-value zone from which we can anchor our thinking on equity
markets. Our review of previous bear markets also highlights
other factors that are likely conditions for a sustainable recovery
to build.
• Most recoveries require at least tentative evidence that the
economic data is stabilising or at least, in the current case,
signs that the economic data is no longer in free-fall.
• In the current environment, we would need to see evidence
that policy measures are successfully mitigating the second-
round effects (large scale business failures or significant and
sustained increases in unemployment) that would imply a
more protracted down-turn.
• Signs that the infection rate is peaking would also be a
necessary requirement in providing some guide as to how
long the extreme containment shutdowns will remain in
place.
From a technical standpoint market bottoms go through a
number of phases: 1) Extreme capitulation or disorderly sell-offs
as positioning gets cleared out. 2) Over-sold bounces and
subsequent re-tests of the downside as new information either
confirms or diminishes market concerns. 3) Recoveries require
the internal dynamics of a market to normalise, reflecting
healthier breadth.
Volatility
Before we focus on our asset-allocation positioning our review of
market history throws up important considerations in terms of
volatility and this is critical when we are thinking of deploying our
total return strategies. Under normal conditions we would not
expect volatility to remain at elevated levels of any length of
time. However, as Figure 19 illustrates, the current bear market
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Figure 19: Volatility and bear markets– Highest realised volatility recorded in S&P 500 Index bear markets
Source: Bloomberg and Insight. Data as at 31 March 2020.
already fits into at least the 'big bear' category from a volatility
perspective. This makes sense in that volatility tends to be at its
highest point when the rate of equity market declines is at its
greatest and, as we have already shown, the speed of the most
recent move is historic. In that regard it is quite possible for
volatility to remain high for at least a number of months. So
unlike, for example, the volatility spike of February 2018 – where
we were quick to deploy total return strategy positions – in the
current environment, we aim to build these positions over time.
Moreover, finding a bottom in a bear market is not
straightforward. After an initial sharp decline the trajectory of
many bear markets often becomes less extreme and price action
more 'two-way'. Again, using the S&P 500 Index as a guide, the
average index ranges we have seen in the first year of a bear
market have been +/-8%, +/-10% and +/-12% on a rolling one, two
and three-month basis respectively. In the GFC we saw at least
six material bounces (between roughly 10% and 20%) before the
MSCI World Index bottomed. To explore this in more detail,
Figure 20 goes back though all our bear markets and plots the
most extreme one-month trading ranges mapped against the
longevity of the bear market (measured in months on the
horizontal access). The take-away is that the ranges are huge, so
for example one-month ranges of up to 20% are not uncommon
even excluding our three mega-bear markets.
Our bear market study has focused on the US stock market
simply because it is the market with the longest history for us to
compare our bears. But using this as our marker we can explore
the dynamics of other bear markets and asset classes. For the
MSCI World Index, we have data going back until 1970 and in the
50 years that have followed we count 10 bear markets that
registered 20% declines or greater. Using this as an anchor point
we can look at the frequency of, duration and scale of bear
market bounces across a wider range of markets which we show
in Figure 21.
Figure 20: Rolling one-month trading range for historical bear markets
Source: Bloomberg and Insight. Data as at 31 March 2020.
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Jun-46 toApr-48
Aug-56 toOct-57
Dec-61 toJun-62
Feb-66 toOct-66
Nov-68 toMay-70
Nov-80 toAug-82
Jul-90 toOct-90
Jan-73 toOct-74
Aug-87 toDec-87
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Oct-07 toMar-09
Current
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Months since start of bear market
Range Average
Great depression bear market: Sep 29 to Jun 32
GFC bear market: Oct 07 to Mar 09
WWII bear market: Mar 37 to Apr 42
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Figure 21: Bear market bounces – A cross asset class perspective
Source: Bloomberg and Insight. Data as at 31 March 2020. A bear market bounce is defined as an up-move in excess of 7% for equities,
and 5% for EM local market debt and the Australian dollar. For US $ debt and high yield our bounce definition requires a 3% rally. The
chart illustrates the average and maximum observed bounces since the 1973-74 bear market – see data notes below.
Figure 21 shows the average 'bear-market bounce' for a range
of different asset classes. It's worth highlighting that the
datasets here do not go back as far as our previous analysis. For
example, our currency (Australian dollar) dataset begins in 1971,
high yield in 1983, emerging market equity in 1987 and emerging
market in 1993. The developed equity market data begins in
1970 with the exception of the UK equity market, which starts in
1983.
Nevertheless, the same message comes across. Rallies of 10%-
15% are not uncommon across cyclical assets and some of the
ranges around these averages are large, particularly for example
around emerging markets.
Against this background, we are embracing a tactical approach
to portfolio management both from a risk-management and
return-generating standpoint. In the near term, we will be
focused on tracking how the coronavirus infection and mortality
rates evolve, and adjusting our views on the likely disruption to
economic activity and corporate profits.
The thought process outlined above is helpful and it gives us
little conviction to hold large directional views on equities at this
point. The pace of risk-asset declines is unlikely to continue at
the precipitous rate we saw in March, but downward pressure
will likely be a recurring theme until conditions for a sustainable
recovery build. As noted above:
• Most recoveries require at least tentative evidence that the
economic data is stabilising or at least in the current case,
signs that the economic data is no longer in free-fall.
• In the current environment, we would need to see evidence
that policy measures are successfully mitigating the second-
round effects (large scale business failures or significant
increases in unemployment) that would imply a more
protracted downturn.
• Signs that the infection rate is peaking would also be a
necessary requirement in providing some guide as to how
long the extreme containment shutdowns will remain in
place.
In terms of our broad beta management, the interaction of
equity markets and government bond markets is an important
starting point. We retain our conviction that government bonds
are likely to be a good diversifier to risk assets in the current
growth scare.
The debate as to whether the policy response to COVID-19 is
eventually inflationary or disinflationary will roll-on. For now we
believe that policymakers have a clear objective to keep bond
yields low or lower (to keep financial conditions from tightening
further), at least in the short term, irrespective of the fiscal
pledges that governments are announcing. In that context we
are maintaining duration at a reasonably high level (over 3.5
years) considering the low level of pro-cyclical risk (equity) that
we are running. Moreover, we have rebalanced our government
bond exposures away from the very long end of the government
yield curves towards the belly, where liquidity is greatest.
PORTFOLIO POSITIONING
Lines show minimum and maximum ranges Average
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Further along the 'risk curve', in credit we have a preference for
investment grade credit over riskier alternatives. We view the
combination of duration and spread as attractive at this point.
Importantly, many central banks (including the Federal Reserve,
European Central Bank (ECB) and Bank of England) have
committed to support investment grade credit (to provide
liquidity) through direct purchases. The ECB's secondary
purchase plan is less all-encompassing than that of the US
authorities but both provide comfort and spreads look attractive
in all but a GFC scenario.
Our preference is for US Investment grade as it appears to offer
better value. Indeed, of all of the asset classes we monitor it
stands alone in already having witnessed a bigger drawdown
than in the GFC, which is no doubt an observation not lost on the
US Federal Reserve.
Figure 22: US IG debt – A bigger drawdown than in the GFC
Source: Bloomberg and Insight. Data as at 31 March 2020.
For now we maintain just small allocations to the riskier end of
spread markets (high yield and emerging market debt). With
regard to the latter, we have taken out our last direct holdings in
local currency emerging market debt and in relative-value space
have a bias for short emerging market currency positions
relative to the US dollar among a range of defensive currency
positions.
Managing the equity return profile is very important to delivering
asymmetry of return over time. Within our strategy, we replace
the concept of a fixed asset-weighted benchmark with a dynamic
risk budget (which in effect provides an element of synthetic
option replication that protects downside) around which we take
active asset allocation decisions.
We began the crisis with a weighting below our long-run
average, and also below the level indicated by our internal risk
budgeting process. We will continue to use it as a guide when
balancing our fundamental views of how the market outlook is
unfolding relative to our risk tolerance, and, for now, our equity
weight remains close to budget and is sub 5%.
The flip-side of this very challenging environment is heightened
volatility and skew (see Figure 23). This provides an attractive
backdrop to look for investment opportunities that can take
advantage of higher volatility to embed attractive asymmetry
such as large down-side buffers on directional trades, or
positions that will pay-off over volatile trading ranges.
Figure 23: S&P 500 Index skew at record levels
Source: Insight. Data as at 31 March 2020.
Obviously, during the initial market shock some of our existing
positions suffered as volatility spiked and markets gapped
through ranges beyond those we thought likely when instigating
the positons. Our risk-management disciplines, including 'trade
waterfall' management and 'stop-loss review levels' proved
helpful in managing these positions and will remain important as
we take advantage of new opportunities looking forward.
We are cognisant of the fact that the high-volatility environment
is throwing up a range of attractive opportunities and we wish to
ensure we have the capacity or risk appetite to take advantage
of these. Against that background, we envisage building our
total return strategy positions over the months ahead as
volatility looks set to remain elevated for some time.
Two other areas of our investment universe have been affected
by the crisis. The dividend futures markets have seen some of
the biggest drawdowns of any asset class. Given the scale of this
crisis, and the need for government cash injections, the prospect
of returning money to shareholders (via dividends or buy-backs)
is low. So, moves in this market were far bigger than even in the
GFC (where it was banks that were the focal point of dividend
cuts). Our early decision to exit all exposures has helped contain
losses but we will monitor the market for opportunities in the
medium term.
In previous periods of market stress the low economic sensitivity
of our infrastructure holdings made these positions relatively
low risk holdings. This time, illiquidity became a problem and
those in the FTSE 250 Index took significant mark to market pain.
We decided to retain positions (partially hedging to take the
edge off mark-to-market moves) and here we expect our
investments to continue to recoup lost ground.
Overall, we retain a very cautious near-term disposition. The
policy response to the coronavirus has been both speedy and
unprecedented in scale. At the very least, it should keep the
credit lines open to corporates and households under pressure.
-18.0%
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Sep-83 Sep-89 Sep-95 Sep-01 Sep-07 Sep-13 Sep-19
US IG Drawdown IG Max Drawdown
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Skew (25dP - 25dC) / (50d) Latest reading
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Whether policy easing will be effective in arresting the economic
impact of a significant demand and supply shock of the type
unleased by a world heath emergency is unclear. Opportunities
inevitably become apparent during periods of market distress
and our objective is to avail ourselves of them. To do that, we
have a tactical mind-set when assessing asset-allocation moves
from here, recognising the fluid dynamics at play.
Our investment processes have served us well during previous
periods of stress. As a growth strategy we aim for a degree of
asymmetry in our return profile, so we are accustomed to
managing difficult market conditions.
Figure 24: Asset allocation
Please refer to the risk disclosures at the back of this document. As at 31 March 2020. Data is given for a representative portfolio that adheres to the same investment approach as Insight’s broad opportunities strategy. Data is shown from inception of that vehicle (September 2009). Positions are shown on a net basis apart from total return strategies which are shown both net and gross. Cash: Includes cash at bank, FX forwards and money market instruments.
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Range of historic net exposures Range of historic gross exposures Current Maximum allocation allowed
Efforts to contain Covid-19 virus heighten the potential for significant economic
impact, reducing attractiveness of equities
Spread markets attractiveness reduced while
growth fears remain a concern
Challenging environment, heightened volatility as the growth backdrop has deteriorated rapidly, are a cocktail for choppy markets. Total Return Strategies (TRS) allow us to generate returns
across a broad range of market environmentsLong-term, stable cash
flows with inflation linkage make infrastructure
attractive
A combination of low inflation and challenged economic growth means Government bonds are an attractive diversifying asset – notwithstanding
valuation concerns
Cash levels increased as we seek to contain risk and look for
new opportunities
THE INVESTMENT TEAM
Insight’s broad opportunities strategy is managed by a team of 11 dedicated investment professionals. They sit within Insight’s
investment division which comprises over 200 front-line investment professionals. The team is able to harness investment ideas
from all the specialist investment units within the firm ensuring that the strategy benefits from a rich source of investment ideas.
The team is specialised in asset allocation, macroeconomic analysis and portfolio construction and has developed a clear and
transparent investment process that allows ideas to be channelled into a robust portfolio specifically designed to meet its
objectives.
IMPORTANT INFORMATION
RISK DISCLOSURES
Past performance is not indicative of future results. Investment in any strategy involves a risk of loss which may partly be due to exchange rate fluctuations.
The performance results shown, whether net or gross of investment management fees, reflect the reinvestment of dividends and/or income and other earnings. Any gross of fees performance does not include fees and charges and these can have a material detrimental effect on the performance of an investment.
Any target performance aims are not a guarantee, may not be achieved and a capital loss may occur. Funds which have a higher performance aim generally take more risk to achieve this and so have a greater potential for the returns to be significantly different than expected.
Portfolio holdings are subject to change, for information only and are not investment recommendations.
ASSOCIATED INVESTMENT RISKS
Multi-asset
Derivatives may be used to generate returns as well as to reduce costs and/or the overall risk of the portfolio. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
Investments in bonds are affected by interest rates and inflation trends which may affect the value of the portfolio.
The investment manager may invest in instruments which can be difficult to sell when markets are stressed.
Property assets are inherently less liquid and more difficult to sell than other assets. The valuation of physical property is a matter of the valuer's judgement rather than fact.
While efforts will be made to eliminate potential inequalities between shareholders in a pooled fund through the performance fee calculation methodology, there may be occasions where a shareholder may pay a performance fee for which they have not received a commensurate benefit.
This document is a financial promotion and is not investment advice. Unless otherwise attributed the views and opinions expressed are those of Insight Investment at the time of publication and are subject to change. This document may not be used for the purposes of an offer or solicitation to anyone in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it is unlawful to make such offer or solicitation. Insight does not provide tax or legal advice to its clients and all investors are strongly urged to seek professional advice regarding any potential strategy or investment. Issued by Insight Investment Management (Global) Limited. Registered office 160 Queen Victoria Street, London EC4V 4LA. Registered in England and Wales. Registered number 00827982. Authorised and regulated by the Financial Conduct Authority. FCA Firm reference number 119308.
© 2020 Insight Investment. All rights reserved. IC2066
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