Portfolio Manager Luke Newman considers how the market for absolute return has changed in response to the spread of COVID-19, outlining his reasons to position for an economic recovery, while still focusing on capital preservation.

  Key Takeaways:

• In what has been a truly challenging year for investment markets, there have been several
  key identifiable phases when it comes to absolute return investment: capital preservation;
  debt issuance; and positioning for a recovery.
• Experience, even at arm’s length, of previous pandemics, has provided precious insight into
  the potential shape of lockdowns, and the difficult political decisions made, as the virus
  spread across the world.
• The future is not a straight or clear path, either in investment terms or in our personal lives.
  In this environment, a cautious attitude seems sensible, while also keeping funds in reserve
  to take advantage of longer-term opportunities, as and when they appear.

Luke Newman: 2020 has been a seminal year for investment markets, and when we look back as we get towards the end of the year, there seems to us to be three distinct stages, particularly when thinking about absolute return investment.

The first phase back in the first quarter for us was all about capital preservation. When I think back at experiences we’ve had in the 15 years of running the strategy, the experience, even at arm’s length, of watching the SARS and the H1N1 pandemics unfold, gave us a great insight into not only the shape of lockdown’s initially in China and Asia, but actually when we joined the dots and understood that for Europe, the UK and the US, we were likely to see very similar patterns of economies being shut down and difficult political decisions being made.

We felt well informed enough to take some dramatic decisions within the strategy. This involved cleansing the long book of industries such as catering, travel, hospitality and then bringing into the short side of the strategies positions that could benefit from the sort of disruption and huge drawdowns we saw within equity markets at that stage.

As we moved on to the second stage, really from late March through into the early summer, the scale of the crisis in economic and social terms was really striking home. And for us, that phase reminded us in financial market terms of what we saw in the global financial crisis of 2008 into 2009, particularly when it came to servicing the huge amounts of financial leverage that had been built up.

We saw huge amount of new debt raised and also in equity markets, a huge number of rights issues and placings that were conducted to plug the holes from the after-effects of the economic lockdowns that have been put in place. Again, within the strategy, that created a huge amount of opportunity as well as risk. But in the tactical book in particular, we were able to navigate first on the short side into those companies and industries where we saw the most financial stress and then where appropriate on the long side to benefit from the relief in investors’ minds when those balance sheets were repaired and businesses lived to fight another day and lived to fight another [economic] cycle.

Over the last few weeks and months, we’ve moved, in our mind, into a third phase of 2020. And that’s really positioning and looking further ahead for a potential unlocking. And it may sound strange to talk about this when around the world we’re experiencing huge problems still with coronavirus and in many cases local or national lockdowns and restrictions being put in place. But of course, financial markets are a discounting mechanism.

And actually we expect, on a 12-month view, a sustained and steady pick up in some of these businesses that [appear] best placed to emerge from economic lockdowns in a strong competitive position. It’s not simply a case of buying markets or baskets or sectors or even value. We need to identify those businesses that have the appropriate balance sheet, either because they were strong going in or have raised money over the last few months. Those businesses that are likely to come out in a stronger competitive position, having taken market share from their competitors. Or even those businesses that have benefited in some way, either from stronger demand through lockdown (thinking about some of the technology-orientated businesses that have done very, very well), or looking at industries that are maybe less fashionable, such as paper and packaging or automotives, where you’ve seen supply coming out of the industry. And again, those financial characteristics are looking, to our eyes, better as we come out into 2021 than maybe they came into the coronavirus crisis in the first place.

What it’s meant is we balanced the strategies a lot more between crude growth and value baskets, after a number of years of being skewed more towards growth-orientated compounding businesses. So positioned much more for an economic recovery to come, while still being cautious.

This won’t be a straight path, for investors or for any of us in our personal lives as well. But we are seeing opportunities and the important thing is to remain calm, make sure we’ve got powder dry to take advantage of those opportunities and focus on not only preserving short-term performance within the strategies, but making sure we’ve got the building blocks to deliver steady, smooth, positive, absolute returns with low levels of volatility and an ability to demonstrate a low level of correlation to underlying equity markets as we go forward into the next few years.