The Investment Committee
12th June, 2020
Blog, Hot Topics
Question the Committee – Coronavirus Edition
A big thank you to all our clients who submitted questions this week – it has been great to continue to get a high level of interaction with our blogs, and most importantly understand areas where you would like more information. Given the volume of responses, we have had to pick a selection, though if we haven’t answered your question directly we will be responding under separate cover soon. Continued best wishes from the DB Wood Team.
When markets were falling in February and March, I was surprised at how much my Portfolio fell by – what actions were taken and would you do things differently next time?
If we take our Low risk portfolio, it fell, from top to bottom by14.5%, compared to the wider market UK equity market which lost 34.2%. This was slightly higher than our normal expectation, though given the circumstances, we were relatively pleased with that level of capital preservation, in what was the quickest 30% correction in market history.
Within three days of the market fall commencing, we reduced our equity weighting by 30%. That was the most drastic change we have ever made to the portfolios in one trade, however it wasn’t just equity markets that got caught up in some of the wild swings – there were even days where AAA rated (the highest possible) corporate bonds, lost 5% in one trading session.
We highlighted in last week’s blog (https://www.dbwood.co.uk/blog/may-portfolio-update-no-rest-for-the-wicked/), that in hindsight we would have come into 2020 with a higher weighting in Government Bonds. That would have further protected our clients’ capital, though at the time they looked extremely expensive, and if Covid-19 had not happened they would no doubt still be sat in negative territory. Moving forward they offer poor value and high risk; one of the key dilemmas we face. We didn’t add Government bonds for what are undoubtably the right long term reasons, but that cost us at that moment in time. Investing is more about the long game than the short game, though, we have reviewed our Government bond position nonetheless and added a small amount for future protection with a view to reviewing the position as the Covid risk subsides.
Given the quicker return of the Medium to High and High Risk Portfolios since the bottom of the market on 23rd March, didn’t the Committee see the opportunity of increasing the equity share across all other portfolios?
Whilst reducing risk early in the pandemic was a key decision, our choice to increase it around the market bottom will be significantly more important to our clients’ long term returns.
As governments were announcing lockdowns there was a point of peak pessimism, and we expected a large policy response as well as a flattening of virus curves across the developed world. As that view starting to come to fruition, we progressively increased the equity share across all portfolios. The market bottom was on the 23rd March, and we increased risk on 17th, 20th, 25th, 30th and 6th April.
Those decisions were made from Low Risk through to High Risk, though those changes were more drastic in the higher risk portfolios, as clients there have a greater appetite towards market volatility, and hence we could be more aggressive.
That isn’t to downplay our actions however, as Low Risk sits over 2% ahead of where it would have been, had we not made any changes at all!
Do you think it is right for governments and Central Banks to intervene so heavily in this recession and what implications does it have for investment markets moving forwards?
Yes – it is vital for policymakers to intervene in periods of economic stress, supporting both consumers and businesses, and providing a better platform for the economy to bounce back. This has been even more important given the health consequences of this crisis, as on this occasion the support has been focused on saving lives as well as jobs.
Probably the biggest consequence of the spending increase is that Government debt levels have risen considerably, and this will have implications for personal and corporate tax rates down the line, as well as potentially for inflation. In addition, Interest rates will now have to stay lower for longer, which we will talk more about shortly.
What do you believe are the best and safest opportunities for your investors in the short to medium term?
Good question – the safest place for anyone’s money over the very short term is cash, though consequently you get virtually no return. Looking to the medium term, then we feel the best risk / reward based opportunities are through holding investments in high quality companies (in certain sectors), via investing in their equity (higher risk investors) or debt (lower risk investors). This is really the core focus of our current investment mix.
Looking past coronavirus, do you think it is likely taxes will rise substantially in order to reduce the mounting debt levels we will be faced with?
This is an interesting long-term question, though is slightly subjective. One thing I think we can all agree on is that it is going to be very challenging for this government to deliver on their election mandate of delivering Brexit, re-building regional economies and moving towards carbon neutral by 2050, without a strong economic recovery. To achieve that both tax policy and spending policy are going to need to be supportive, so it will be interesting to see how the government approach this.
Putting it in perspective, UK government debt to GDP is quickly converging on 100%, though the US has been running over 100% since 2012 and Japan operates consistently over 200%. It is therefore possible to run high debt levels for quite a long time, providing interest rates remain low enough that it doesn’t cost too much.
So, whilst we can’t say tax policy won’t change over the coming years (it more than likely will), we feel it is unlikely tax rates are increased too heavily. Instead, interest rates are likely to be kept lower for longer, even if a strong recovery leads to higher inflation, which the Bank of England typically aim to avoid. Consequently, cash rates will remain very low, and therefore if combined with some inflation, the buying power of cash will erode (as will the Government’s debt).
From a planning perspective, our technical team are reviewing the potential tax changes that could be introduced from the Autumn budget, to ensure we have our fingers on the pulse to act quickly to make the most of any changes in legislation.