COVID-19: Unigestion’s risk-managed equity strategies positioning

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COVID-19: How Unigestion’s risk-managed equity strategies are positioned during this black swan event and period of market turmoil

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Overview

On January 30, 2020, the International Health Regulations Emergency Committee of the World Health Organization declared the outbreak of the Novel Coronavirus (COVID-19) a “public health emergency of international concern”. As we write, over 81,000 people in China have been infected with the virus, with a further 104,000 cases elsewhere. 155 countries/regions have now been affected.

In this paper, we discuss the positioning of our risk-managed equity strategies, assess the performance since the emergence of the virus and outline what we believe the immediate future may hold.

Active Management – Adapt Quickly and React to Changing Market Conditions

The rapid escalation of the COVID-19 outbreak is highlighting, in particular, the importance of active judgement and context. Compared to an index/rule based investment strategy, we have been proactively analysing both our top-down (country, industry and style) and bottom-up (stock level) decisions.

Our proprietary World Growth Nowcaster model assesses the economic conditions of individual countries. Since February 21, we have seen uncertainty rising, coinciding with the spread of COVID-19 cases beyond China. It is a negative factor to growth assets and to the underlying economies, harming consumption and postponing investment projects. It also perturbates the global supply chain with complex consequences for corporates and a negative impact on market liquidity.

We are keeping a close eye on the development of the COVID-19 crisis and its impact on our Growth Nowcasters. Based on this, we have been reviewing our exposure to Thailand, which is one of our largest overweights, and are rebalancing our equity portfolios to take into account the new Coronavirus-related risk factors.

Since the outbreak, Thailand has been hit hard due to its high exposure to tourism, particularly from China. The tourism industry represents roughly 15% of the country’s GDP and Chinese tourists account for 1 out of 3 international arrivals. Thailand also entered this challenging period with a relatively weak economic momentum and exports, as well as tourism, which will take a hit short-term. In response, the central bank has cut interest rates to 1% (a historical low) and with a 40% government debt to GDP ratio, there is ample room for a large fiscal stimulus package.

From a bottom-up perspective, we are carefully assessing our positions in stocks with significant exposure to the virus, in particular holdings linked to the tourism and travel businesses. For instance, we have taken action on some of the most exposed stocks such as the Airport of Thailand, Krung Thai Bank and Central Pattana (shopping malls, food courts, hotels), whose business is heavily exposed to COVID-19 uncertainty from Thailand. Likewise, with the US imposing travel restrictions, we have decided to sell our positions in Grupo Aeroport Del Pacific because the US-Mexico border could also be shut down to contain the Coronavirus. In developed markets, we have proactively reviewed and trimmed our exposures on Aéroports de Paris and Flughafen Zurich, among others.

On the other hand, within emerging markets, we remain long in Top Glove, the world's largest rubber glove manufacturer. The company produces a comprehensive range of rubber glove products from natural and synthetic rubber and orders for these and other protective medical equipment have seen a spike. In developed markets we continue to favour Roche given its defensive characteristics, reasonable valuations and sustainable growth (i.e. growth is expected in multiple areas ranging from sclerosis, haemophilia, immunology and ophthalmology).

Downside Protection During a Black Swan Event

To better understand the market impact of the current outbreak, we examined the response of our risk-managed global equities strategy during other similar situations, analysing relative performance during the 2009 H1N1 Pandemic Influenza, the 2013 Avian Influenza A (H7N9) and the Ebola Virus from 2014 to 2016. The strategy tends to exhibit a smaller drawdown than the broader market when such black swan events occur.

How Have our Risk-Managed Equity Strategies Performed?

The strategies favour industries such as telecommunications, utilities and pharmaceuticals, which are relatively immune to economic cycles and have more defensive characteristics. These companies provide products and services that are needed in both good and bad times. On the other hand, the portfolio is less exposed to retailing and media & entertainment when compared to the market index.

Since the start of the outbreak, our strategies have outperformed their respective regional benchmarks for estimated month-to-date performance and for estimated year-to-date performance as of March 16.

Looking Ahead Equity Strategies

In our view, the current sell-off was borne out of the combination of fears for expected future economic growth, extreme valuations and market specifics such as the weight of systematic and passive strategy positions. The number of people affected by the disease surged outside of Asia, meaningfully increasing the possibility of seeing the same type of massive quarantines that were implemented in China and jolting investors out of complacency. In Europe and the US, big corporations have advised their employees to avoid travelling for business, schools have closed, hotels have been quarantined and summits cancelled in a global effort to stop the propagation.

So far, our portfolios have shown some downside resilience and we expect them to provide even better protection over the longer term. During significant market corrections, dispersion usually remains low initially, as systematic de-risking negatively impacts all stocks indiscriminately. We expect more dispersion to materialise in the coming weeks should this correction persist, as stocks with more robust fundamentals and valuation levels should ultimately benefit from better investor confidence.

The current market drop overshoots market corrections we have seen so far and if history is of any guidance, volatility could persist for many more months, with more dispersion in the future and some rebounds/range trading periods.

We witnessed similar behaviour in October 2008 from our global portfolio, when the strategy posted an initial downside capture above 85% while the market was losing more than 20%. The second leg of the drawdown, once market dispersion increased between winners and laggards, saw our strategy protect significantly on the downside. We expect equity markets to behave in a similar manner as the world moves into a general lockdown period.

Within our equity portfolios, we are consistently implementing our risk-managed investment process, applying both quantitative and fundamental analysis to continuously monitor the risk from a stock, sector and country basis.

From a quantitative perspective, we make sure that our forward-looking volatility and correlation forecasts remain robust in the current environment. In particular: a) our in-house risk model is relying on a dynamic look-back period based on the current implied volatility level (VIX index) in order to best adapt to current market conditions. In the current environment, the look-back period tends to shorten which puts more emphasis on the current risk factors; b) we are closely monitoring our transaction cost model to make sure it accurately represents the current environment where spreads have increased dramatically.

From a fundamental perspective, we are focused on detecting stocks with new emerging risks linked to material exposure to international travel, oil, basic materials, discretionary consumption and growth. Another important risk indicator being monitored is the evolution of Credit Default Swap (CDS) spreads of countries and underlying portfolio stocks – these are indicative of the implied default probability.

Finally, yet just as importantly, we naturally pay high importance to valuation and the recent price dynamics of such stocks, in order to make sure that we can act before these risks are fully priced in.

COVID-19

COVID-19

COVID-19 equity strategies

COVID-19

COVID-19 equity strategies

COVID-19 equity strategies

Article by Anastassia Lescure and Michael (Xiaochen) Sun, Client Portfolio Management

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