Portfolio and Market Review 2nd Quarter 2020

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Back to Square One

“If you change the way you look at things, the things you look at change.” - Dr Wayne Dyer, an American selfhelp author and a motivational speaker.

As we locked down in late March, it was hard to imagine that we would see global markets return to thelevels of pre-lockdown society as early as June. We have just lived through one of the most volatilequarters the world has borne witness too. Volatility has not only been prevalent in the financial markets butin the emotions of every one of us during unprecedented recent events. Protests, riots, a demand forchange; all while COVID 19 remains a severe threat to the vulnerable and elderly.

However, our portfolios are built to withstand these types of events. By using over 100 years of historicaldata, we build global portfolios, best positioned to capture the returns of the continuously resilient globaleconomy. Figure 1 below depicts this ideology. Although we switch on the news and find the economicoutlook to be a dim affair, one must be disciplined to find facts through the noise. Whilst the shouting andscreaming has come from those quoting the decline of the popular market indexes such as the FTSE 100and S&P 500, the global market cap weighted index, upon which your portfolios were built, has returned to exactly where it was at the beginning of 2020. Thus, the value of your portfolio will most likely be just shy of the value it held whilst you toasted your drink on New Year’s Eve to a prosperous, uneventful and stress-free 2020.

Figure 1 – Cumulative Year to Date Performance of a Globally Diversified Portfolio.

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What have I lost then?

To heed the advice of Dr Dyer, let’s look at things in another light. Instead of financial loss, let’s look at thisin the perspective of time lost or “delayed gain”. The average recovery period from a bear market for theFTSE All-Share is 648 days. 1 The current global market cap recovery is nearly complete as shown above,and we are only through 135 days. For a globally diversified investor, this has been an extremely fastcorrection so far.

The fastest 30% drawdown in the history of global equities in the first quarter, followed by the largest 50dayadvance in market history in the second quarter has not been easy to digest. Nonetheless, it is out of ourcontrol! Unless by the off chance you happen to be a global economic policy maker, the chances are youare pretty helpless during a global market crash correction. Not to fear, an investment is a long-termjourney that we have been prepared for from the start and like anything there is a price for admission –occasionally we have to wait and stay patient during market downturns before continuing in the upwardtrend that is just around the corner. Please see our Growth of Wealth chart in the Appendix; correctionshave occurred before and will happen again, pay your admission and keep going.

1 AJ Bell (2020)

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Due to the recent lockdown, there have been significant restrictions on trade in key sectors along with asevere limit on travel. Global tourism, retail and other key industries have been crippled, meaning theeconomy may have some way to go before it sees a return to its normal prosperity. We know one of thebest measures of economic productivity and output is the Gross Domestic Product (GDP) indicator. InFigure 2, we have used data from the IMF and the World Bank to map GDP back to 1961.

Whilst we have seen a massive contraction in GDP over the past months, this data shows that the decline isnot out of line with past GDP cycles. The pattern of GDP growth reflects the natural business cycle phases:expansion, peak, contraction, and trough. They do not occur at regular intervals, but they do haverecognisable indicators. The third phase, indicated by the arrow in Figure 2, is a contraction. It starts at thepeak and ends at the trough, when it turns negative for two consecutive quarters, that is what we would calla recession.

We can therefore say with the confidence of over 50 years of GDP data, that the business cycle has acted inline with its model and we should therefore experience an expansion in the form of global reopening in thecoming months – indicated by the IMF’s dashed forecasted line. 2 Commentators are noting that theeconomy is “on track for a “V” shaped recovery”, this initial fast paced GDP growth rate, we would arguewas due to an overreaction to the potential negative economic impact of COVID 19 on global business. 3

2 IMF (2020)3 Capital Economics (2020)

Figure 2 - Real GDP Growth (Annual % Change, Dashed Line Represents IMF Forecast).

Economic Outlook

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“You make most of your money in a bear market, you just don’t realise it at the time.” - Shelby Cullom Davis,an American philanthropist and founder of investment management firm Davis Selected Advisers.

During market corrections, you will hear market commentators brandish the term “market volatility” around incessantly. However, we very rarely stop and ask why we fear volatility and what risk it poses to our portfolios.

In our opinion this is a market timing issue directly correlated to the previous statements made aroundbeing patient. This has been the highest period of volatility in the US stock market since the VolatilityIndex’s (VIX) inception in 1999 – the VIX is a real-time market index representing the market’s expectationsfor volatility over the coming 30 days. The US market makes up 57% of the FTSE Global All Cap Indexmaking it a very good indicator of the general trend of global volatility. Therefore, if we have seen thehighest so called “risk” to your portfolio in the form of volatility but year to date we hold the same portfoliovalue, where is the risk?

The risk lies in the behaviour of the investor. Our natural biases tell us to flee danger at the first sign of itand consequently when markets begin to bounce between large daily losses and large daily gains - literallythe 3rd worst day and the 10 th best day in S&P 500 history 4 - the undisciplined investor wants out due to the uncertainty of where the value of their portfolio may end up. By combining both the behavioural coaching of a financial adviser and a diversified market cap weighted portfolio that captures global returns, we can negate the effects of volatility in the long run.

By coalescing all of the points above, a long-term disciplined investor can sleep easy at night knowing thattheir hard-earned cash is diversified across a buoyant global economy.

Volatility – A Risk to Who?

4 Carlson (2020)

Figure 3 – Cumulative 15 Year Performance Overlaid with US Stock Market Volatility

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Asset Class Returns

The strong quarter seen by equities and bonds took place as governments pledged unprecedented levels offinancial support to temporarily closed businesses and households. Central banks across the world actedto assist with the recovery, introducing a number of policies, including reducing interest rates, in somecases to historically low levels, while also reducing capital requirements for banks in the hope of increasinglending. As lockdown eased, data suggests that some of these policies already seem to be having an effectwith signs of a sharp economic rebound. In the US, retail sales increased 17.7% 5 in May, while in the UK thefigure was 12.0%. 6

Although signs of a rebound look promising, the virus has not been fully contained and the difficult task offinding a vaccine remains. The pandemic has disproportionately affected certain countries. Althoughinfection rates have fallen in Europe, parts of Asia and the UK, many countries, especially those in emergingmarkets, such as India and Brazil, are struggling to contain the spread. The US, perhaps surprisingly as adeveloped nation, continues to see cases surge. There has been a dislocation between the medicalstatistics and stock market performance however and US equities returned 20.4% in the quarter whileemerging markets returned 18.5%. 7

The relationship between European and UK equity markets is interesting. After a fairly similar downturn inthe first quarter of the year, the UK market lagged in its recovery compared to its European counterpartsover the subsequent three months. The UK economy contracted -20.4% 8 in April and although signssuggest the economy will quickly recover once lockdown is lifted, overall the UK is predicted to contract by -11.5% in 2020 if the virus does not return, or -14.0% if there is a second wave. This compares to globalforecasts of -6.0% or -7.6% respectively, 9 highlighting the importance of maintaining a global outlook withregards to investments.

The macro backdrop has been reflected in equity returns. The chart on the following page shows UKequities have suffered, particularly over the 1-year and 3-year return horizons while other markets haverecovered more quickly, leaving the UK lagging both over the short and long term. The strong quarter for USstocks extends their outperformance over longer time periods.

Over the short term, bonds have performed comparatively well, supporting our philosophy of diversificationto reduce risk by investing across a variety of uncorrelated assets. Global property has sufferedconsiderably and has yet to recover to the extent of other asset classes. This is to be expected as indirectproperty holdings, such as REITs, tend to fall more quickly and deeply during a downturn.

5 U.S. Department of Commerce (2020)6 ONS (2020)7 FE Analytics (2020)

8 ONS (2020)9 OECD (2020)

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As economies re-open and the immediate threat from COVID appears to subside, we are likely to see mediaattention turn to other areas of potential risk. Tensions between China and Western powers overHong Kong, the South China Sea and spying have increased in recent months; not only threatening toremove any progress made in relation to the simmering trade war between the US and China but alsoincreasing the chance of tariffs between China and other nations. Brexit is still to be resolved. With littleprogress being made during the pandemic, the UK government decided not to seek an extension to thetransition period by the June 30th deadline, and so the UK will be leaving the EU at the end of the year, withor without a trade agreement. The fast-approaching US Presidential election in November also addsuncertainty. The Democrats appear to lack a strong contender capable of toppling President Trump butwith social unrest across the country and Kanye West announcing his intention to run for presidency, well,stranger things have happened!

Rest assured we will not be trying to predict the outcome of any of these scenarios and our portfoliosremain positioned for the long term.

10 Corporate Bonds: Bloomberg Barclays Global Aggregate, UK Gov Bond: Bloomberg Barclays Global Aggregate UK Government Float Adjusted, UK Equities: FTSE All Share, Global Property: FTSE EPRA Nareit Global, Emerging Markets Equity: MSCI Emerging Markets, EU Equities (ex-UK): MSCI Europe ex UK, Japanese Equities: MSCI Japan, US Equities: MSCI USA, Global Value Equities: MSCI World Small Value, Global Equities: FTSE Global All Cap, UK Inflation (RPI): UK Retail Price Index.

Source: FE Analytics (data as at 30 th June 2020) 10

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Following the rapid equity market correction, portfolio returns over 3 and 5 years are now positive across allmodels. Portfolios with 50% plus allocations to equities are still in negative territory over the last year, butthe gap has closed considerably during the quarter and portfolios with lower equity weights have positive1year returns. Naturally, the portfolios with a higher concentration of growth assets were more heavilyaffected by the downturn and will take longer to recover. This is in line with the reduction in the fixedincome allocation and the negative correlation of returns these assets have with equity investments.

The Betafolio 100% equity portfolio had a 1-year return of -15% to the end of March, which has pulled backto -3.5% at the end of June. This very significant move directly reflects the stock market recovery shown inFigure 1 (page 2) and evidences the benefits of not attempting to time the rebound, instead riding out themarket cycle and maintaining exposure. The FTSE Global All Cap index grew by over 6% during the first fourdays in April - waiting on the side lines trying to predict the recovery while not being invested would havebeen costly, even for this very short period.

Portfolio Performance

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Take a deep breath. We know that this has been a very extreme quarter, for those who are new investors ithas been a great lesson and one that you should keep in the memory bank for as long as possible. Forthose experienced investors, well this has been what you have been preparing for since the last correctionin 2008. Nonetheless, if you take anything away from the above reading it should be that disciplinedinvesting will be rewarded in the long term and market corrections are no different to any other time in themarket. We do not know what will happen tomorrow, in 6 months, nor ever, and the graphs throughout thiscommentary should be hung in your home as a reminder to that effect!

We leave you with the words of presidential candidate, Kanye West (did you ever think you would see that ina financial report?).

The risk for me would be in not taking one - that’;s the only thing that’s really risky for me.

Closing Remarks

Appendix

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AJ Bell. (2020, 03 19). How long does it take to beat the bear? Retrieved June 30, 2020, from Investcentre:

https://www.investcentre.co.uk/articles/how-long-does-it-take-beat-bear#:~:text=The%20average%20time%20it%20has,385-day%20average%20market%20downturn.&text=But%20it%20needed%201%2C529%20days,peak-to-trough%20decline.

Capital Economics. (n.d.). Global State of Play: Recovery and Beyond.

Carlson, B. (n.d.). Explaining the 2020 Stock Market. Retrieved June 6, 2020, from A Wealth of CommonSense:

https://awealthofcommonsense.com/2020/07/explaining-the-2020-stock-market/

IMF. (n.d.). World Economic Outlook (April 2020). Retrieved June 30, 2020, from International Monetary Fund:

https://www.imf.org/external/datamapper/datasets/WEO

OECD. (n.d.). Economic Outlook No 107 - June 2020 Double/Single Hit Scenario. Retrieved June 8, 2020, fromOECD Stat:

https://stats.oecd.org/index.aspx?DataSetCode=EO

Office for National Statistics. (n.d.). GDP monthly estimate, UK: April 2020. Retrieved June 8, 2020, from Officefor National Statistics:

https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/april2020

Office for National Statistics. (n.d.). Retail sales, Great Britain: May 2020. Retrieved June 8, 2020, from Officefor National Statisitcs :

https://www.ons.gov.uk/businessindustryandtrade/retailindustry/bulletins/retailsales/may2020

U.S. Department of Commerce. (n.d.).

https://www.census.gov/

Retrieved June 8, 2020, from United StatesCensus Bureau:

https://www.census.gov/retail/marts/www/marts_current.pdf

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