ROUNDTABLE ON ASSET ALLOCATION AFTER COVID-19
We held our fourth Linchpin roundtable webinar on 10th June on the subject of asset allocation AC (after COVID-19). Thank you again to Aoifinn Devitt for moderating our panel of:
Daniel Booth, Chief Investment Officer, Border to Coast Pensions Partnership
Roy Kuo, Team Head, Alternative Strategies, Church Commissioners for England
Leslie Lenzo, Chief Investment Officer, Advocate Aurora Health, Illinois
Michael Howell, Founder and Chief Executive Officer, CrossBorder Capital
Mark Steed, Chief Investment Officer, Arizona PSPRS Trust
As the strategist on the panel, Michael Howell set the scene by saying the scale of intervention by central banks over the past three months has wrong-footed investors. It does not necessarily imply that economies will follow the market rise but, relative to safe assets, equities are still comparatively under-valued and under-owned.
Michael’s latest update on liquidity has data up to the end of June and is entitled “It’s a Big Beautiful V”*. The data confirms the case for a V-shaped market recovery on the basis of the unprecedented liquidity creation which he has been noting since late March. Looking forward, he sees this crisis as one of refinancing. Apart from Germany all nations have fallen deeper into debt in the past ten years and something like US$60tr of debt needs to be refinanced each year, and that will put pressure on bond yields.
He noted the relative attractiveness of equity markets today and opined that investors need to look for alternatives to fixed income given its negative yield. He also noted the chasms appearing in public markets due to the recent volatility and as displayed by recent stark performance moves. On this basis private assets are relatively more attractive: an approach reflected in some other panellists’ views.
Inflation was the subject of much debate. Michael commented that the Supplier Deliveries Index in the US had been a good leading indicator of inflation in the 1960s and 70s and has risen sharply in recent months. He thinks US inflation might exceed 5% in 2021, though this may be simply a ‘bump’. Another panellist estimated the output gap would reach about 10% and therefore didn’t expect sustained inflation to kick in for some time. However, the long-term consensus of most panellists was that debt would eventually be monetised leading to higher inflation.
The panel also addressed the subject of hedging this risk. As inflation can take place in many guises, it is complex and any hedge carries substantial basis risk. One experienced strategist suggested producer price inflation is the best target. Another dismissed the fashion for gold, which has poor correlation with CPI and which investors tend to buy at the wrong time.
Turning to asset allocation, a number of panellists have taken advantage of the market dip to sell less volatile assets (hedge funds were mentioned by two of them) and to take on risk, mainly equities and credit. One made the point that this was simply following their rebalancing discipline, while another had taken advantage of strong performance in CTA strategies to recycle capital into other hedge funds strategies such as credit. A further comment was that it is too early to assume the virus won’t come back but most agreed it was time to put the pedal to the metal and be invested in risk assets.
Several commented on how they have worked with their parent institutions on cashflow. The COVID-19 crisis has, for many, reduced operating cashflow and one panellist said their parent entity had factored future income to ensure that they do not have to come back to the investment team for operating cashflow reasons.
Longer term our panel all have plans to reconsider their strategy but have not yet made moves. One commented that the recent crisis represented the ultimate stress test and, given that they had essentially weathered this storm, it demonstrated that their asset allocation was robust and futureproof. Another is responding to the current expected low return environment by applying around 10% leverage to the fund in order to achieve a higher rate of return on the basis that a portfolio of over 60% alternatives will exhibit lower day-to-day volatility. No panellist had an explicit risk mitigation portfolio in place.
We discussed the shifts in real estate use, where demand is clearly going to be softer in many sectors for some time. One panellist commented that we would remain office-based creatures. It was noted that UK supply in the past few years has been slow, so yields here may hold up better than expected.
We looked at a slowing down of allocations to private markets; there was a general preference for private equity over credit. We also discussed whether the fact that private asset values are not marked to market disguises volatility. Is it risk which is disguised or do daily marks overstate public market volatility for longer term investors? One commentator suggested that owning private equity or credit gives long exposure to inflation and the US economy.
There was a split between preference for passive and active investments, but value was generally seen as a beneficiary of rising bond yields, albeit vulnerable to economic disappointment. There was full agreement that owning government bonds is a licence to lose money.
We ended by asking what returns our panellists expected over the longer term. The general response was around 7% nominal from equities or about 3% real. Which, of course, equates to inflation of around 4%.
* available from Linchpin here.