Fundamental Equities: Investment update as the COVID-19 crisis intensifies

Fundamental Equities: Investment update as the COVID-19 crisis intensifies

26-03-2020 | 投資觀點
Strong volatility. After a very volatile week, due to rising concerns about the consequences of the COVID-19 pandemic, global equity markets appeared to pull themselves back together over the past few days, as they welcomed massive global monetary and fiscal stimulus announcements. Yet, the situation remains fragile and the news flow could quickly turn negative again.
  • Fabiana Fedeli
    Global Head of Fundamental Equities

Speed read

  • Global economic activity already severely curtailed, a recession is likely
  • Value opportunities emerge but we are mindful of buying value traps
  • We are gradually and selectively adjusting the portfolios

As already explained in previous market updates, we believe that the impact of the coronavirus pandemic on global economic activity will depend to a large extent on the policy response from governments, in particular on the duration and extent of economic activity shutdowns. We are becoming increasingly concerned about the extent and depth of the economic impact, and a global recession has now become our base case scenario.

It Is now clear that H1 earnings will be severely affected around the world. However, countries that have been able to resume activity earlier than others should fare relatively better. This explains the recent outperformance of the Chinese equity market, as the country has managed to contain the outbreak and the impact thereof, and is slowly going back to normal levels of economic activity and demand. However, history tells us that a global recession would most likely imply an underperformance of equities relative to other asset classes. Within global equity markets, the US equity market is most likely to outperform, as it is often perceived to be safer, also from a currency perspective.

Yet, given the recent market sell-off, there are still opportunities to be found in equities. Using data going back to 1873, we find the S&P 500 peak-to-trough decline around a US recession has been 22.1% on average. This suggests that the stock market has now already fully priced a US recession. For emerging markets and European equities, a recessionary scenario is also priced in. So, we are now closer to the end than to the beginning. More negative news, such as company failures, further expansion of the pandemic and potential delays in policy response, will determine when we reach the bottom. Above all, once earnings are announced, they will inevitably have an impact on stock prices and market volatility.

We have been here before: markets will recover and regain their losses. However, experience tells us that this is not a market to buy indiscriminately. We need to make sure that we are picking the right stocks. In a rebound, the tide will lift all boats. But, once the impact on earnings is known, it will become clear who the winners and the losers are. Some companies will have more difficulty recovering, others will never recover.

Picking the bottom of this market is next to impossible as it depends on a number of exogenous and difficult-to-predict factors. As long-term equity investors, we have learnt that the best strategy is to slowly and gradually pick our entry points. Also, we need to be mindful of the significant increase in intraday volatility and bid-ask spreads, that increase transaction costs significantly. This is a market of opportunities, but not across the full market spectrum. It is a market for active investors and careful stock pickers. Some of our teams, depending on the value they see emerging in their respective markets, have started to gradually and selectively pick entry points.

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Impact on portfolios

The performance figures mentioned in the following sections are gross of fees, as of 24 March.

Global Stars
We are sticking to our defensive positioning. The strategy has outperformed the market, both month to date and year to date, by respectively 240 and 508 basis points. We maintain our 5-6% cash position and will wait for four more favorable signals to materialize:

  1. The coronavirus contagion curve flattening
  2. More fiscal stimulus
  3. Credit markets stabilizing
  4. Investment outflows as sign of a capitulation

Currently, most signals point to caution.

European Stars
The Sustainable European Stars strategy has fared relatively well, so far. Over the year to date, the portfolio has lost around 25%, while the MSCI Europe Index fell by some 26%. In particular, the strategy has held up reasonably well since the end of February, outperforming the benchmark over the month to date by 10 basis points. We have made few changes to the portfolio. We proportionally reduced the overall exposure to financials and increased positions in staples and healthcare as a measure to reduce risk. Our cash levels remain broadly unchanged.

Emerging Market Equities
The value tilt of our Emerging Markets strategies will typically underperform in risk-off markets. Emerging Stars’ performance trails the market by 4.9% this year, of which the majority was incurred this month. However, over the 25 years that our team has existed, we have learnt to use market overreaction to find opportunities. Hence, we have been gradually changing positioning where better risk-reward emerged. The most likely mistake by value investors in economic downturns is to sit in value traps, i.e. companies that will be either structurally affected by the economic downturn, or for an extended period. Balance sheet health and earnings outlook remain key.

Asia-Pacific Equities
The past week saw wild trading in individual stocks and heavy trading volumes. There are clear signs of technical positions being unwound in some stocks (long or short), which led to price moves unrelated to fundamentals. We are making use of some of these opportunities to add or reduce positions. However, bid-ask spreads are high, and trading is expensive. We have therefore been trading sparingly. For Asia-Pacific Equities, we added to our Japanese yen hedge, at levels where the currency was considered too strong and too much like a safe haven. Our Value style has not helped this year and relative performance year to date stands at -3.7%, of which two-thirds was incurred this month.

Global Consumer Trends
The strategy posted negative absolute returns (as of 24 March, in euros: -11.1% MTD and -12.5% YTD), and yet strongly outperformed (roughly 6% MTD and 10% YTD) the index. Quality growth stocks again outperformed their cyclical value counterparts significantly. Avoiding cyclical sectors, such as banks, energy companies, airlines and carmakers, had a positive impact on performance. Some segments of consumer spending, like luxury, travel and retail, have been clearly affected by market volatility. Other segments, including consumer staples, home entertainment, e-commerce, food delivery, Indian and Chinese stocks, have shown greater resilience. We keep buying gradually and selectively, as no drastic portfolio changes are needed.

New World Financials and Fintech
Both strategies posted negative absolute returns during March, although both outperformed their reference index in the year to date. New World Financials posted a return of -26.5% in the month to date and -31.6% in the year to date (as of 24 March, in euros). The strategy underperformed by roughly 1% in the month to date, yet outperformed by 1% over the year to date. Fintech has outperformed since the beginning of 2020 (+1%) although March has been difficult (-21.5% MTD versus -17.2% for the benchmark). In relative terms, both strategy have held up well in the year to date. Individual holdings have shown unprecedented volatility, with large price swings on an intra-day basis. Regarding the Robeco New World Financials strategy, life insurers and consumer finance-related stocks underperformed. The strategy’s structural underweight in banks, as well as its positions in the digital finance and fintech segments, had a positive impact on performance. Positions in some segments that showed stronger resilience, such as exchanges, subscription-based software and Indian and Chinese stocks, were beneficial for both the Robeco New World Financials strategy and the Robeco Fintech strategy. We had lowered exposure to consultants significantly before March and continued this during March. We are trading as little as possible. We have started to consider adding positions in beaten-down stocks with solid long-term fundamentals, such as alternative asset managers and certain emerging finance stocks.

The strategy showed strongly negative absolute returns, both on a year-to-date ( as of 24 March, in euros: -20.4%) and a month-to-date basis (-15.8%), but fared better than the MSCI AC World Index (outperforming by 1.5% MTD and by 2.8% YTD). Fears concerning a global recession and restrictions on global mobility are putting pressure on sectors such as automotive, luxury and capital goods. Insurers also performed poorly on lower bond yields and dysfunctional capital markets. Positions in consumer staples, telecom towers, data centers, gaming and cybersecurity proved more resilient. The Healthy Aging trend came out as the weakest trend month to date, due to our positions in the insurance sector. The Industrial Renaissance trend was the best-performing trend, help by cybersecurity stocks. We made very few changes to our portfolio, apart from adding slightly to two bombed-out names that we expect to do well in the eventual upturn.

Robeco Digital Innovations
The strategy posted negative absolute returns of 15.4% in the month to date, outperforming the MSCI AC World Index by 1.9%. In the year to date, the strategy is also outperforming by 1.9% (as of 24 March, in euros). Our Automation & Robotics sub-trend showed the worst performance, as investors now price in recessionary scenarios. Companies in this subset of our investible universe are exposed to the capital expenditures of their clients and are therefore highly sensitive to downturns. Meanwhile, the Digital Enablers sub-trend performed mostly in line with the MSCI AC World Index. Companies in this subset of our investible universe depend more on the operating expenses of their clients, which usually prove more resilient. Our third sub-trend, Secure Digital Infrastructure, clearly showed the best relative performance. Companies in this subset of our investible universe should benefit from the sudden increase in the need to work from home and the consequent spike in demand for secure digital infrastructure. Our portfolio managers are constantly on the lookout for new investment opportunities but have refrained from implementing significant changes in the portfolio, as market conditions remain too volatile and current positioning is considered satisfactory for the longer term.

Chinese Equities
Most recently, we reduced our exposure to sectors more directly affected by the coronavirus pandemic, in particular retail and tech hardware. We used the proceeds to add positions in online gaming stocks that should benefit from the outbreak. We believe risks are still skewed to the downside for valuations and that consensus earnings estimates have not priced in the likelihood of a global recession. As a result, we are focusing on controlling risk. Our cash levels remain broadly unchanged. After a solid 2019, the (almost) first three months of this year have again been strong in terms of relative performance. Year-to-date outperformance stands at 4.5%.


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