Coronavirus volatility lays bare generational split towards investing

The pandemic-driven sharp increase in market volatility has highlighted investors’ different attitudes to portfolio management, while underlining the critical role of wealth planning and the importance for advisers to remain close to clients, especially the younger ones, in times of crisis.

The generational split has certainly been emphasised by the wild daily gyrations in the equity market earlier this year, as stocks plunged 30 per cent in most G20 nations during March, on the back of recession fears linked to the global shutdown.

While older, more experienced investors reacted with relative calm, having already lived through a financial downturn, be it Black Monday, the dotcom bubble bursting or the 2008 global financial crisis, younger generations needed far more handholding.

Not only did more mature investors show confidence that markets would recover, but they were also keen to participate in the market upside, explains Simon Reed, executive director within the Private Investment Office at discretionary wealth manager London & Capital.

“Younger clients are more sensitive to the short term and they need to be reminded of their longer-term objective,” he explains. Cutting equity exposure once their portfolio has made a significant loss would only mean crystallising losses.

Now that markets have rebounded strongly, investors tend to believe that the level of “exuberance” in markets is overdone and dislocated from real economies, which is also the house view at London & Capital. “With lockdowns easing, we are probably going to see an element of celebratory spending, but doubts remain about the longer-term effects on behaviours,” adds Mr Reed. Consumer spending is expected to increase but to lower levels than pre-crisis, with areas such as tourism, the airline industry and commercial property occupancy bearing the brunt.

Positioned for the long term, keeping a relative low exposure to equities of around 45 per cent in a balanced risk portfolio, the firm focuses on “high quality, low leverage, strong franchises with defensive earnings streams”, today avoiding the consumer discretionary area, with preference for staples.

“The risk for clients is that with a strong rebound in the economy and associated effects on markets, our portfolios will lag, but in a sideways scenario, of low growth and low interest rates, we will do pretty well,” predicts Mr Reed, expecting volatility ahead, and potentially another pull back in markets, caused by an acceleration of Covid-19 cases or second waves. “If markets are falling back, we will also be pretty resilient to those falls.”

Hardest hit

Recent client research carried out by UBS points to millennial HNW investors as the hardest hit by the pandemic. In the UK, almost 80 per cent of this younger cohort worry they do not have enough savings should there be another pandemic, compared to only 10 per cent of baby boomers. Nearly 50 per cent of them express concerns about losing their job.

“Millennial investors are feeling particularly nervous financially, and we expect to see changes in how they manage their wealth as a result,” says Mark Goddard, head of HNW business in London at UBS Wealth Management.

But across all age groups, HNW individuals have not been immune to stresses being felt across society. Seventy-five per cent of wealthy investors, at a global level, see their old way of life changing forever, although only a quarter believe the pandemic has significantly affected them.

Yet, almost 80 per cent of rich individuals see volatility as an opportunity, with more than 80 per cent indicating they did want more guidance than usual from their financial adviser during times of uncertainty.

“Most HNW individuals who have been invested for some time were relatively comfortable with remaining invested, particularly those who have been through a market cycle and experienced volatility previously, and have a clear purpose of their wealth,” confirms Mr Goddard.

“Challenging discussions” were held with those individuals that may have come into wealth in the more recent past and experienced the sharp market correction just after starting investing.

At UBS, wealth planning conversations focus on clients’ goals and objectives, with assets split into three ‘L buckets’. These include the liquidity bucket, to meet clients’ needs over the shorter term, the longevity bucket, which provides assets at varying stages of an individual’s lifetime, and legacy assets. These include funds which clients may pass on to family members or give away on philanthropic causes.

“We explain to clients that they do not need to spend too much time looking at daily market moves, and can afford to take more risk with money they are unlikely to need in the short term,” states Mr Goddard.

The pandemic has also accelerated long term trends, such as healthcare and technology, fuelling an even stronger interest in sustainable and impact investing.

Conservatism

Among clients, entrepreneurs have been far more conservative, especially those running smaller businesses in which they hold a significant stake. “We have seen a much higher degree of conservatism around that personal wealth,” says Mr Goddard. Several of them liquidated their personal investments to hold more cash, concerned about the future of their business. Many decided to sell down some investments and repay debt, in order not to have the same degree of gearing in their overall balance sheet.

But the proportion of cash held in client portfolios is still high. Many clients were waiting for a market correction, which allowed the bank’s advisers to be “very proactive” with clients, when the market did correct in March and April.

For more cautious individuals, a “phased approach to investing” proved a popular strategy. “This also allowed the establishment of a regular dialogue with clients and a regular pattern to investments,” says Mr Goddard. “We genuinely believe in the principle that ‘it is not market timing, but time in the market that is key’.”    

In this unprecedented crisis, the proportion of clients that redeemed their equity portfolios was “extraordinarily low”, reports David Bailin, chief investment officer, Citi Private Bank, estimating it to be 20 per cent of what would have been in 2008.

“Markets moved down and back so quickly that most of our clients did nothing, which proved  to be exactly what they should have done, which is not to trade these markets,” he says.

Timing the market is extremely difficult and the effect of bad market timing is shown by the fact that investors that missed only the two best days of the US stockmarket every year in the past decade – just 20 days over the course of 10 years – would see their returns fall from plus 7 per cent to minus 3 per cent. And two of the best days for this year occurred right after the market crash of March 23.

Mr Bailin points out that HNW clients held a cash balance of more than 20 per cent in 2009 after the global financial crisis, which has continued increasing over the years. “But cash was of no value to them in the last 11 years and it will be even less value to them over the next decade,” he adds.

Clients should reduce their cash balance to between 5 and 2 per cent of their assets, and invest the rest of their portfolio in assets suitable to this new economic cycle.

In the first few months of the pandemic crisis, the global private bank gained exposure to industries expected to be least impacted by the pandemic. These also overlapped with the “unstoppable long term trends” identified by the bank in late 2018, including digitalisation, longevity and associated investment in healthcare, Asian development and next energy revolution.

But extraordinary fiscal and monetary policy and massive dispersion in asset prices, determining a huge bifurcation between winners and losers, more recently drove the bank to gain greater exposure to undervalued assets, with good recovery prospects, such as Latin America and US small cap equities, as well as real estate, assets to which Citi has now an overweight position.

Looking forward, ‘Covid cyclicals’, including banks, insurance companies and retail, are expected to be profoundly impacted by the pandemic, while ‘Covid defensives’ are believed to be more resilient. These include sectors such as IT, grocery stores, and industries that will benefit from the new environment, such as e-commerce.

These two shares groups typically range between 45 and 55 per cent of total market capitalisation. But the pandemic has pushed up the prices of the defensives, dividing the entire equity world into a 70/30 relationship between defensives, which are “somewhat overvalued” and cyclicals which are “deeply undervalued”.

 “This ratio will mean revert over the course of the next 24 months back to a more normal pattern and it represents one of the most profound opportunities for investors over the course of the next two years,” explains Steven Wieting, chief investment strategist and chief economist at Citi Private Bank.

Asset price inflation

Because governments and central banks were so quick to support the market and more importantly the economy, there was “very little panicking” among clients, reports Willem Sels, global chief market strategist, HSBC Private Banking.

Most clients have been able to hold on to their asset allocation and, in many cases, have increased their equity exposure. “Clients that had already experienced the 2008 crisis knew that asset price inflation can benefit both equity and bond markets, even in a difficult market environment,” explains Mr Sels.

Global liquidity, the reopening process and the reduction of tail risk around the world will result in an asset price inflation, which leads the bank to have a “mild overweight” on equities and gold.

The reopening process is going to be “slow, volatile and uneven”, predicts Mr Sels, recommending investors not to be “overly cyclical” in their sector exposure.

Geographical diversification and selectivity are key. “As we are focused on quality, we are not participating in the rotation we have been seeing in markets since mid-May,” which has spurred investors to move further into lower quality and into more cyclical assets and in geographies like Latin America.

HSBC has in fact taken profits on its Latin America position and cut it to underweight, while in the equity space it has an overweight position on the US and China, having recently upgrading Europe to neutral.

Investing in quality assets, within diversified portfolios including gold and alternative assets, enables investors to stay invested and manage volatility in the short term.

In the longer term, opportunities are found in sectors such as healthcare, the online economy and automation. After trade tensions and the pandemic, companies will want to make their supply chain safer and more secure, bring their supply chain home and automate it, believes Mr Sels.

Many investors are having trouble understanding the current behaviour of equity markets, he adds, because this is, to some extent, “a confidence crisis”. Consumer confidence will take time to come back, which explains the discrepancy between the real economy and markets.

What today differentiates the market from the economy is central banks’ support and asset price inflation. Moreover, stockmarkets are skewed towards large cap companies. These are in better economic shape than small caps, which represent large part of real economies.

Also, equity markets tend to look beyond the reopening process. All these factors support stockmarkets. 

Back to basics

The pandemic has spurred a change in investment mindsets, reports Joseph Poon, group head of DBS Private Bank in Singapore. Spoilt by the bull market since the global financial crisis, many investors got “very comfortable” and forwent the tenets of diversification and long-term investing which the Asian bank advocates.

In March and April, “many investors lost lots of money” because in the V-shaped recovery, they were scared out of the market when it started to fall, and did not get back in when the rebound started.

Those who “stayed put” throughout the crisis were the clients who had followed the bank’s advice of investing in its barbell diversified portfolios. These invest on one side in growth-oriented stocks, capturing secular trends, such as e-commerce, the ageing population and the rise of millennials, and on the other side safe income-producing assets. This barbell strategy has also outperformed the market during the crisis, claims Mr Poon.

“A lot of clients are now going back to the basics of investing, as they have realised that what they have done in the past has not worked,” he says, hopeful that clients will remember these lessons in the future.

“We are having many more conversations with clients and a lot of new mandates are given to us to manage portfolios on a diversified basis.” Also, many risk-averse clients have started investing in broad portfolios of fixed income run by the bank, as cash no longer offers any return.  

There is a similar attitude across client segments, across all ages and backgrounds, adds Mr Poon. “Fear is a great equaliser, and people are looking for ways to reduce their fear in this uncertainty.”