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Archives for April 2020

The Active Passive Debate Continues – With Active Management Well Ahead On Points

By Rebecca Thomas

In the COVID-19 era high volatility is the new reality but Rebecca Thomas, Chief Executive Officer Mint Asset Management, explains why investors need a steady hand in shaky markets. 

In what looks now like an exquisite piece of market timing, the Financial Markets Authority (FMA) ‘active v passive’ debate on February 19 this year coincided nearly exactly with the historical peak of the NZX50.

The following day the benchmark NZ share index topped 12,000 for the first time – a height it sustained for just one more trading session before tumbling, slowly at first and then in rapid freefall, to the rock-bottom of about 8,500 on March 23.

Investors used to the generally placid conditions of post-GFC markets would be in for the shock of their lives. The March volatility, triggered by the coronavirus economic lockdown, marked a new extreme even for experienced professional fund managers. NZX share prices came unhinged during the 30 per cent descent from peak to trough.

In theory, times of heightened volatility throw up more opportunities for active managers as quality stocks often hit bargain basement prices. However, it is not as simple as just buying everything that appears cheap – especially with so many unknowns still around COVID-19.

Active managers need a strong investment process to maintain buy-and-sell discipline in erratic markets and understand risk. Passive investors, of course, do not require discipline – but they are exposed to risk whether they like it or not.

Time runs out for momentum

As leader of the, winning, active team in the February FMA debate, I made the point that investors need to focus on risk-adjusted returns rather than the nominal benchmark figures.

However, despite coming out ahead on the night, NZ active managers in general have been on the losing side of the debate over the last year or so.

It has been very hard for active managers to outperform the NZX over the last couple of years as upwards momentum and stock-specific performance has dominated the market. This is commonplace in the latter stages of a long bull market.

Over 2019, for example, the median NZ wholesale equities fund underperformed the standard NZX50 index by about 1.3 per cent before fees, according to figures from consultancy firm Melville Jessup Weaver (MJW). For periods of three years or more, the average NZ shares manager either stayed on par or outperformed the benchmark.

Interestingly, during the bumper December 2019 quarter the median manager in both core NZ equities and

Australasian shares beat their respective indices, the MJW report shows. 

While investors might have been expecting a more subdued, but still upwards trend in the NZ share market through this year after a stellar 2019, the COVID-19 crisis abruptly halted the momentum complacency.

During March entire sectors (aviation, tourism, for example) faced wipe-out – at least in the short- to medium-term – as others, such as healthcare, received a potential boost.

Share prices reacted accordingly in March as investors, for better or worse, adjusted their portfolios in line with worst-case scenarios.

Indiscriminate buyers and sellers like passive funds were inevitably caught in the ebb-and-flow of market panic with no capacity to adjust portfolios in line with the major changes COVID-19 measures have wrought on the NZ economy and markets.

Fundamental reset for the long term

At a time like this, fundamentals become more important than ever as companies first battle for survival and then plot a strategy to thrive in what will certainly be a different operating environment for some time to come.

Active investors who can identify those firms likely to come through the crisis in better shape will be well-placed to create long-term outperforming portfolios.

And, the emphasis should be on the long term. Quarterly performance results won’t capture the full impact of the March market dislocation but they provide an insight into its unusualness. 

The just-released MJW March report shows the average manager underperformed the index over the three-month period in almost every asset class, including fixed income, which faced particularly extreme distortions as the global economy ground to a halt.

However, NZ shares was a stand-out sector for active managers during the March quarter where the median manager outperformed the benchmark by about 2 per cent, according to MJW. The average NZ shares fund did relatively well, “despite a smattering of Australian market exposures across the group which would have been a headwind”.

For example, the Mint Trans-Tasman Fund – the best-performing NZ shares strategy in the MJW table over the March quarter – was down just 8 per cent over the three months compared to about -15 per cent for the index. No one likes to lose capital but a focus on capital preservation and a clear understanding of a manager’s fiduciary obligations in turbulent times helps us to navigate our course.

On volatility watch

Higher market volatility is likely to roll on for months, or years, giving active investors the ability to accrue high-conviction stocks at low prices.

With so much uncertainty remaining as both the NZ and global economies adjust to the new coronavirus realities, share markets are unlikely to stabilise any time soon.

But patient, active investors with a well-defined strategy and robust implementation program have a better chance than most to come out in good shape on the other side of the storm.

Indeed, volatility management has always been central to the Mint investment philosophy, which carefully weighs risk against return.

We believe – based on research both offshore and here in NZ – that lower-volatility stocks actually produce better long-term returns. In this environment, volatility has increased across all stocks but relative price stability remains a key indicator of corporate health and long-term profitability.

For example, the MJW figures show the Mint Trans-Tasman portfolio reported the lowest five-year average volatility of all funds in the category – lower, even, than the index itself. 

Since the March 23 low, the NZX index has mounted a strong but somewhat fragile recovery, climbing to almost 10,800 in the third week of April, paring losses from the February peak to about 10 per cent.

Of course, the last couple of months would have been perfect for market-timers – but only perfect market-timers. 

Buying high quality stocks at the right price and being patient is a more sensible approach than trying to time the bottom. 

Disclaimer: Rebecca Thomas is Chief Executive Officer at Mint Asset Management Limited. The above article is intended to provide information and does not purport to give investment advice. Mint Asset Management is the issuer of the Mint Asset Management Funds. Download a copy of the product disclosure statement here

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The Great Disruption

By: Bevan Graham

Managing Director and Chief Economist, AMP Capital New Zealand

In 2020 global growth looks set to post its first negative result since the depths of the Global Financial Crisis and may even prove to be the weakest year of global growth in living memory. Unemployment rates are rising fast, underlining the widespread social harm.

Two things make this recession quite unlike any I’ve seen before. The first is the speed of the contraction in activity and the weakness in markets that has come with it. Secondly, this is not a recession borne of a prior build-up in economic imbalances. As regular readers will know, none of our traditional recession indicators have been flashing red, making this a classic ‘Black Swan’ event. The reason asset markets have taken this shock so hard is that many indicators were improving well into February. Shocks from outside the financial system are much harder to quantify and value in asset prices.

None of our traditional recession indicators have been flashing red, making this a classic ‘Black Swan’ event.

The deterioration in the economic outlook has been marked by significant and widespread policy easing across both the developed and developing world. Central banks have cut interest rates, and implemented or expanded asset purchase programmes. Indeed, the most recent multi-trillion dollar commitments by the US Federal Reserve (the Fed) have led commentators to note that in effect, the Fed now “controls interest rates and the broad bond market” for the first time in history.

As we have discussed many times before, given the lack of progress on monetary policy normalisation since the Great Recession, fiscal stimulus has also been widespread, though the quantum has varied from country to country. The lack of prior economic imbalances suggests that while the recession will be deep, the period of contraction will be relatively short – perhaps it’s better to describe this as more of an economic disruption or dislocation than anything else.

The pace at which activity resumes will be determined by the pace of the spread of the virus and the extent to which various economies re-open for business. The best example of this is here at home where it seems likely we will move gradually back down through the various alert levels with a gradual resumption of economic (and other) activity as we move through the levels. Of course, this path assumes sustained improvement in infection prevalence – any pattern of an initial apparent virus retreat followed by a second-wave resurgence in cases would be of graver concern.

So while the length of time economic activity contracts, we expect two to three quarters at most with most of the damage done in the current June quarter, and don’t expect a sudden bounce back to pre COVID-19 levels. We also need to bear in mind that it is not only the economic activity level in New Zealand that will be a decisive factor, but how well our major trading partners manage their own containment and recovery processes.

Indeed, recovery will be hampered by the extent of business failures during the shut-down. One characteristic of recessions is that clearly not all firms survive. The positive spin on that is that marginal firms fail during the recession, freeing up resources for new firms to emerge during the recovery.

We have not had a recession in more than 10 years as central banks all around the world have acted aggressively to stamp out even any hint of economic weakness. That has us concerned about the quantum of business failures we may see out of the current disruption in activity. For firms that went into the lock-down in an already fragile state, fiscal support may not be enough to save them. Mergers between firms out of necessity will become common across many sectors of the economy, as occurred in the financial sector during the severest phase of the GFC. This is a slow process.

That all means that while the drop in economic output and the rise in unemployment have been very sharp, the recovery back to pre-lockdown levels will take longer as demand AND supply will likely be constrained for some time. So while the drop in activity has been quite unusual in its scale and pace, the recovery may look more like a traditional recovery from recession.

If that is correct, we might start to see some outcomes that have been missing in the period of growth since the GFC. Depending on the relative extent of damage to supply and demand, we may see some inflation start to emerge. And given the way in which we are all now having to embrace technology, the recovery might come with gains in productivity.

But there are also risks. In particular, we are concerned about the prospects of a prolonged period of higher unemployment and implications for the housing market. Consumer debt loads are historically high, and though mortgage servicing is aided by low interest rates, an unemployment spike would be problematic for many borrowers.

Our biggest concern since the Global Financial Crisis has been the lack of ability for monetary policy to respond to the next crisis. That concern has only been alleviated by the fact that many countries had at least some room to move on fiscal policy, though today we worry about any meaningful progress in achieving a cohesive regional Eurozone fiscal response.

As we come out of this period of extreme weakness, there will be a need to normalise monetary policy from even more extreme levels, but also to restore fiscal balances to more sustainable levels. In New Zealand we are expecting Crown net debt levels to rise from around 20% of GDP to 45% over the period ahead. Getting that back under control to prepare for the next crisis will require spending restraint at some point. Some countries may also need to consider higher taxes of some form. These are both long-term pieces of work leaving the global economy vulnerable until fiscal buffers are re-established.


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COVID-19 & Market Update

The Environment
There is not much we can say about Covid-19 that you won’t have already seen in the media. The spread of the infection and
the impact that it is having globally is, as everyone is now saying, unprecedented. That said, in most countries the rate of new
infections does appear to be slowing, and policy makers around the world are looking at how they can relax social distancing
measures (without incurring a second wave) and ease open parts of their economies.
Immunity and/or a vaccine are needed for the world to re-start properly though. Without which we expect our borders to
remain tightly controlled. There is some hope for a vaccine with Professor Sarah Gilbert of the University of Oxford stating
her group are in the early stages of a vaccine that, if it works, may start production in September. If it works is a big question,
but Professor Gilbert’s group has had success previously in rapid vaccine development.
Other highly experienced and well-resourced research groups are tackling the same problem – and many are sharing
information and data. So, being optimists, we think there is hope for rapid development of a vaccine. Even so, getting
medical confidence in a vaccine by September still leaves an enormous logistical question of it how can be produced in the
quantity the world needs and delivered across the globe.

The Markets
Last week saw a rally across the world as markets took heart from the early indications of a lower infection rate, and ongoing
fiscal and monetary stimulus efforts around the world.
The USA announced an additional US$2.3 trillion expansion of the Federal Reserve’s balance sheet (which will take it soon to
total assets of US$11 trillion). The additional allocation includes $500bn for municipalities, starting the Paycheck Protection
Plan liquidity facility, $600bn for the Main Street Lending program (loans to SMEs), and expanding the Primary and Secondary
Market Corporate Credit Facility and the Term Asset backed Securities Loan Facility to $850bn.
In conjunction with the fiscal packages, the USA is throwing unprecedented stimulus across most parts of their economy. This
won’t stop a sharp economic slowdown but it will make the trough a lot shallower – helping drive the rally last week in risk
One of the key indicators that we are watching is the growing number of job losses being registered in the USA. Jobless
claims rose over 6m for the second week in a row, bringing total claims to 17m for the past four weeks. This has marked one
of the most devastating periods in history for the American job market, as first-time claims for unemployment benefits have
surged more than 3,000% since early March.*
*CNN Business Report
Meanwhile another battle of sorts has been playing out on the backfields, namely oil, with OPEC+ eventually coming to an
agreement to reduce production by ~10m barrels per day for two months. Oil markets haven’t been particularly excited by
this agreement as there had been an expectation of larger / longer lasting production cuts. Estimates of 35m barrels per day
of demand destruction due to Covid-19 suggests that the 10m bpd production cut is insufficient by itself to stabilise the Oil.

The Diversified Funds
The equity hedge that we mentioned in the last report has been removed from the Growth fund and reduced by 3/4s in the
Income fund. Net growth asset exposure is 25% in the Income fund and 81% in the Growth fund.
We have used the big down cycle to start reinvesting the portfolios and, with the recent rally in growth assets over the past
week, the work continues to manage the daily swings in market volatility.
We continue to remain underweight bonds in the Income fund. We cannot justify owning bonds at the moment and, as a
consequence of this, cash levels remain fairly high.

Australasian and Property Equities
All of our portfolios have been taking the opportunity to reset weights in our high conviction stocks.
The Auckland Airport (AIA) placement early last week was a very good example, and an opportunity to lift our holding in the
airport from relatively low levels. While we think border controls will stay in place, and the earning environment over the
next few months will be difficult, the longer-term view is that we think this is still a great place to have some investment.
We continue to hold higher than normal cash allocations in the Australasian Equity fund and the Australasian Property
Securities Fund to take advantage of buying opportunities.
A case in point being Metlifecare (MET). The acquirer of Metlifecare issued a notice to the company that they are triggering
the Material Adverse Conditions clause in the takeover agreement and withdrawing from the deal. MET responded that there
is insufficient change in conditions for the clause to be triggered and that the deal should stand. This created quite
remarkable volatility, giving us the chance to add to our holding at very low levels.
Volatility remains fairly high, even though markets have bounced a bit from their lows in March.
As mentioned in our last update the negative impact of the Covid-19 pandemic on the property sector was swift and brutal.
The normally defensive attributes of the property sector were overlaid with the risk that many tenants (particularly retail)
will struggle to pay their rent, with a number already asking for rental reductions. The length of the lockdown in New
Zealand, and the move to lower restriction levels will be key to how the NZ property sector performs over the medium term.
The property portfolio was able to participate in both the AIA and MET opportunities discussed above.
As well, the property portfolio has re-weighted into Precinct and Kiwi Property Group – both well capitalised groups that had
been oversold.

Looking ahead
We anticipate that the Covid-19 rate of infection should continue to abate, due to the social distancing measures taken
across the world. However, without a vaccine, those same social distancing measures will need to remain in some form for
quite some time to keep the virus contained – even though Level 4 lockdown might be relaxed in coming weeks. Hence, the
economic implications still have some time to play out, and volatility across the markets will remain elevated. This creates a
dynamic environment for both risk and opportunity. At the risk of showing both my age and taste in entertainment – Lets be
careful out there…

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