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Archives for February 2020

Effect On The Economy From Coronavirus Spreading Outside Of China

We expect you are noticing the media headlines regarding coronavirus and the higher levels of investment volatility. We want to reassure you that we continue to actively monitor your investments closely.

The effects of coronavirus spreading outside China will clearly have a negative impact on economic activity and share markets as the crisis is dealt with.

At Milford we have been monitoring the outbreak since it began. Recognising the rising economic risks, and also aware that share markets were likely to move downwards as investors digest the ongoing news, our diversified funds took action early to reduce some exposure to shares. This has already helped to cushion some of the impact of negative share markets over the past few days.

As active managers, we have the flexibility to adjust our portfolios in real time based on our assessment of the risks and rewards on offer. Market volatility such as what we are currently experiencing provides opportunity for us to deliver better outcomes for our investors over time.

We appreciate that trusting in the investment process can be challenging at times. Investment markets will both rise and fall over time – this is very normal. Investors should be wary of reacting to headlines and before making any major changes be sure to ask themselves if their investment objectives have changed or if they are simply feeling nervous due to news they’re hearing. It might help to review your risk appetite and investment time horizon.

Our investment team continues to monitor the situation in real time and is making decisions within the funds accordingly. Whilst there is uncertainty in the short term, we believe that in the long term it is likely that global economic growth will continue, supported by low interest rates and by governments poised to respond.


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2020 Morningstar New Zealand Award Finalists

Morningstar recently announced the finalists for the 2020 Morningstar New Zealand Awards and Mint Asset Management has again made the short list for the domestic equites award after winning the category last year.

Rebecca Thomas Chief Executive Officer & Executive Director said she was thrilled to once again see the Mint Australasian Equites Fund make the shortlist, which reflects the fundamental investment approach Mint has been delivering since the fund was established back in February 2007.

Aman Ramrakha, Morningstar Australasia’s Director of Manager Research Rating said in their media release “In 2019, all major asset classes had positive returns, in particular New Zealand equities, which set a high hurdle for active managers. As the pool of assets in New Zealand continues to grow steadily, Morningstar’s annual Awards highlight the quality of investments available to New Zealand investors. Being nominated for an award is a testament to the fund manager’s ability to offer consistent, high-performing investments that help investors reach their financial goals.”

Anthony Halls, Head of Investments at Mint, said the last 12 months to December was both challenging and very rewarding for investors and it’s a great reflection of the team approach and expertise at Mint to consistently deliver good returns while managing the portfolio with the least amount of risk.

Morningstar determines the winner based on a combination of qualitative research by its manager research analysts; risk-adjusted returns over medium- to long-term periods; and performance in the 2019 calendar year. Morningstar’s Manager Research analysts assess the track record for a fund based on Morningstar’s Risk-Adjusted Return measure over the one-, three-, five-, and ten-year periods. The objective is to screen for fund managers that have provided consistently strong returns, and not just reward those with the most impressive one-year return.


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Investors Have Their Noses To The Wind For The Source Of The Next Crisis

Investors have their noses to the wind for the source of the next crisis. The terrifyingly titled pile of debt, known as “leveraged loans”, could be starting to pong. At Harbour we remain vigilant, monitoring the US market, but taking comfort in the structure of markets down under.

Leveraged loans are simply private market borrowing by sub-investment grade companies[1]. The US leveraged loan marketplace provides well over $US1 trillion in funding for companies involved in private equity buy-outs, gearing their balance sheets or funding expansion. Banks provide around half of this funding with the remaining share going to institutional investors, hedge funds, insurance companies and non-bank finance companies[2]. Banks underpin support for a sizeable European market also; the New Zealand market is tiny in comparison. But we do have leveraged loans. For example, the debt funding used by a private equity firm to buy TradeMe is considered a leveraged loan.

Potential warning signs

  • Rapid growth: The US leveraged loan market has more than doubled in size since 2010, leading to greater corporate vulnerability via higher indebtedness.
  • Lax underwriting standards: In addition to accepting higher gearing levels from borrowers, lenders have increasingly permitted more aggressive accounting to weaken their covenants. For example, intangibles now make up a far greater percentage of assets in debt/asset ratios and management earnings adjustments, baking in yet-to-be realised earnings, make up a significant portion of earnings in debt/EBITDA ratios. Worse still, the portion of loans with lax covenant packages, known as “cov-lite” loans, has soared as shown below.

Leveraged loans v2
Source: LCD (A Standard & Poor’s company)

  • Loans for dividends: A large volume of leveraged loans have been used to fund dividends while business investment has remained subdued.
  • More securitisation: A greater portion of leveraged loans are finding homes in collateralised loan obligations (CLOs – the loan equivalent of Mortgage-Backed Securities).

The makings of a credit cycle

Poor quality loans are more likely to experience losses when corporate profitability dips. If losses are material enough, this can reduce banks’ broader appetite to lend as they recapitalise, thus impacting the real economy.

Leveraged loans2

There are reasons for optimism that the leveraged loan sector would not cause a banking crisis. We examine these along with our more balanced view:

Leveraged loans3
Source: FSB taken from banks’ supervisory filings.

The leveraged loan sector can be de-risked if US corporate profitability growth remains strong while the standards of new loans improves. We saw encouraging, but tentative, signs of this in Q4 2019.  Loan losses remain below long-term averages.  For now, we watch corporate profitability as a lead indicator for loan quality as well as continuing to monitor loan growth and underwriting standards.

The Harbour Income Fund has funded sub-investment grade borrowers via the Australasian high yield market.  The lack of issuance of bank capital securities has provided borrowers a favourable environment in New Zealand. Harbour has had limited participation in the few deals that have been issued in this market owing to issuer-friendly pricing (low yields) and generally weak investor protections.  Meanwhile, not only have we found spreads more rewarding in Australia, but covenants have also offered investors more protection.  For example, Australian payment technology firm Afterpay is not allowed to make any distributions to shareholders while our bonds remain outstanding. In another example, the bond documentation of Australian data centre owner-operator, NextDC, permits it to pay dividends only when net debt / EBITDA remains below 1.5x. Many of the recent New Zealand high-yield deals included no protection.


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Impact Of Viruses On The Economy

Key Points

  • Novel Coronavirus (2019-nCoV) is a more contagious coronavirus than Severe Acute Respiratory Syndrome (SARS) and Middle East Respiratory Syndrome (MERS), but fortunately, has a lower fatality rate so far.
  • While we can look to SARS for the potential economic impact, China’s position in the global economy is far larger now than it was in 2002/03.
  • Equity markets have typically rallied once the number of new cases peaks. We are not yet at that stage and expect volatility until that happens.
  • We have added to some stocks with structural tailwinds that have been sold off as a result of the event. But otherwise, we are taking a vigilant stance continuing to emphasise longer term positive structural influences.
  • This is continually evolving, World Health Organisation (WHO) situation reports are being produced daily and are available online. In addition, cases are being tracked in real time here.


There are several types of coronaviruses which have impacted humans since the mid-1960s. The more recent versions of coronaviruses are Severe Acute Respiratory Syndrome (SARS) and Middle East Respiratory Syndrome (MERS).

Each coronavirus tends to have different characteristics, and this latest coronavirus, Novel Coronavirus or 2019-nCoV, is no different. The data so far shows that 2019-nCoV is far more contagious than SARS or MERS, but fortunately is less deadly with a mortality rate of 2%, much lower than SARS (9.6%) and MERS (~35%). So far, the fatalities have been most prevalent among older males with existing respiratory issues such as emphysema.

According to the latest WHO report (February 3, 2020), there are 20,571 confirmed cases of 2019-nCoV, which has claimed the lives of 426 people (425 in China, 1 in the Philippines) so far. Somewhat critically, up until this point the number of new reported cases has continued to accelerate. As well as the severe human toll, there will of course be an economic impact resulting from reduced consumer confidence and activity, disruptions to supply chains and complications to logistics.

Source: Bloomberg, WHO, Johns Hopkins

Economic Impact

It is far too early to accurately estimate the economic impact of 2019-nCov. While past epidemics, such as the SARS outbreak in 2002/03, can offer some insight into the possible economic impact, direct comparisons will prove to be inexact. China’s share of global output today is over double what it was at the onset of SARS, and China’s share of global trade is around 2.5 times what it was in 2002. Consumption and services, areas likely to be most negatively impacted, are now a much larger share of China’s economy.

Another key factor around the economic impact is the swift steps taken by China to contain the virus. While widely criticised for the slow reaction to contain SARS, China’s response to contain 2019-nCov has been faster and more extensive this time. An outcome of this is that the reaction, which will save many human lives, will likely result in a larger short term hit to activity than SARS did. Chinese authorities, cognisant of this, have already announced a raft of stimulus measures to cushion the economic blow from 2019-nCoV. These include injecting liquidity, cutting central bank repurchase rates, lowering lending rates and fees for companies and regions most affected by the outbreak and encouraging banks to not call in loans to affected firms. Despite this, it is likely that we will see GDP growth expectations cut for the first half of 2020 and, globally, monetary policy will remain accommodative.

Market Impact

We have already seen sharp market movements as this situation has unfolded. China, commodity and tourism exposed stocks have been hit the hardest. Some healthcare stocks have benefitted from expected higher healthcare spending. Chinese A-shares, which resumed trading after an extended Chinese New Year break, closed down -7.9% on the first day of trading; albeit they continued to recover somewhat as new stimulus policy measures were announced.

Bond markets have benefitted from a flight to quality. Since confirmation of Novel Coronavirus on January 7th, the 10-year US Treasury yield has fallen 35 basis points (bp) to 1.52%, close to the September 2019 low of 1.42%. Expectations of rate cuts from the US Federal Reserve have doubled, from one rate cut over the next 12 months, to two. In New Zealand, our 10-year government bond yield has fallen 23bp to 1.23% over this time, and expectations of our Reserve Bank easing over the next 12 months has increased from 14bp to 22bp of cuts.

Global commodity prices have fallen more than 10% in response to the Coronavirus outbreak. The Commodity Research Bureau’s (CRB) Index is currently around its lowest levels since early 2016. Oil prices have dropped more than 20% since early January, with Dubai crude oil (the most relevant benchmark for New Zealand) currently USD55 per barrel. Milk futures provide a real-time gauge of the impact on New Zealand commodity prices, and they have fallen 3% since the Coronavirus outbreak.

In terms of the market impact, as opposed to economic impact, we believe history is a potential guide. In previous epidemics, markets only recovered after the number of new cases peaked. We recently heard from a coronavirus expert, who believes it may not be until mid- February, at the earliest, that this occurs.

Below we look at the impact SARS had on markets in 2003.

Source: Bloomberg, MSCI. Outbreak date February 6, 2003. “Low” is the low of the Hang Seng index.

How we are positioned

We do not profess to know more about 2019-nCov than anyone else. We have tapped our global research partners and contacts to learn more about the virus from experts, and have attempted to understand what the past can, and cannot, teach us.

Having a long-term investment focus, which aims to identify companies that will benefit from structural change, means that, at the margin, we have added to some stocks with structural tailwinds which have been sold off as a result of the event. But otherwise, we are taking a vigilant and patient stance.

Within fixed income, portfolios were structured for rising interest rates as forward-looking economic indicators and government spending plans are supportive for future growth. Following the disease outbreak, we have reduced this position, purchasing assets that will perform well if the Reserve Bank lowers the Official Cash Rate (OCR).

It would also be remiss to not mention that, prior to the outbreak of this unfortunate virus, we were seeing increasing evidence of a U-shaped rebound in global activity. Chinese activity indicators were improving, which was helping the European manufacturing sector to show signs of bottoming. The latest read of US Manufacturing PMI, released February 3rd, also showed a rebound in activity. So, while undoubtedly growth will be revised down for H1 2020, the silver lining may be that it did not hit during the period of economic weakness we saw in mid-2019.


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