This article originally appeared in The Australian on 1 June 2020
How do we invest and construct portfolios in a post-COVID world?
At a high level the answer is easy – we should construct portfolios, because of the high level of uncertainty, with equal weight on profit and on protection.
But what exactly does that mean? What do we need to consider in making such decisions?
More than anything else we need to be aware of the great opportunity these market conditions represent due to heightened uncertainty. It’s why, as investors, we must remain positioned to profit from the social and commercial shake-out we are experiencing.
However, we must also position for protection because while communities are slowly easing lockdown measures, the uncertainties ahead of us that could end badly are still numerous. Could an awful situation become even more awful? Maybe.
On the immediate issue of the pandemic itself there is great uncertainty, first as to the path of the virus. Will there be a second or third wave? New mutations? A vaccine? Effective treatments? Can the health system cope? A new virus entirely?
Then comes a wave of questions about the magnitude of the economic damage, the business failure, the job losses caused by the lockdown and by residual virus fears.
And finally, uncertainty about both the immediate and longer-term effectiveness of the stimulus measures designed to see us through the crisis and rebuild on the other side.
What do we think we know already?
- Deglobalisation has arrived, with a distinct desire in many countries to fund, manufacture and consume locally.
- It’s an uneven downturn and it will be an uneven recovery — some sectors are booming (technology), others are crippled (aviation) and yet others are being seriously shaken up (property and retail).
- Big government debt means interest rates that will remain lower for longer and a much larger role for government in shaping the economy.
- The US will be dominated by political tensions domestically while externally its key issue will be difficulties with China. Separately, US markets will be dominated by the giant technology utilities (Facebook, Amazon, Apple, Alphabet, Google).
- Europe will do what it always does — work gradually through its eurozone challenges while Little Britain goes it alone.
- Australia will struggle from reduced immigration and weak consumer activity but will muddle through on the back of our resources, our stability and our safety.
- Asia, dominated by China, will continue its century of ascendancy, bringing with it new prosperity in many emerging markets.
So, if this is the big picture of post-COVID world, how might we reflect that in portfolios? What choices should we make?
First the protective side
You should have plenty of cash on hand and plenty of liquidity. Find a good at-call account that delivers a return three times the official cash rate and use that instead of term deposits which might offer up to 25 basis points more to lock up your cash for the full term. Don’t fool yourself that term deposits offer genuine liquidity.
Ready and available cash is the firepower all portfolios need to take advantage of the current spate of capital raisings and new issues as well as ongoing market volatility.
Then have a solid core of downside-protected assets that earn their place on the investment bench. Build a defensive portfolio of bonds, credit, hybrids where you can have a high degree of conviction about your “return of capital” as well as your “return on capital” which should be three to five times the return on your at-call cash account. Understand the country, currency, sector and capital structure exposure in all of these assets you invest in.
On the profit side
You may consider shifting slightly back to home country bias but with solid exposure to global technology utilities and global consumer and health staples as well as Asian and emerging markets growth.
But this is not the time to buy the whole haystack to save the effort of looking for the needle. Passive investing won’t offer downside protection in volatile markets or optimal exposure in such a differentiated downturn and recovery. Active managers and careful sector and stock selection are vital in these conditions.
As always, watch portfolio sizing and ensure sufficient diversification. There are many things we think we know but we can all be wrong.
In fact, a healthy dose of humility is called for at present. We are all learning something new every day as we move on from coping and surviving the recent turmoil to adjusting and adapting to the present and future conditions.
The best investors always apply obsessive curiosity with humility to help them keep making better decisions on all new data as it emerges.
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