14 March 2020

SARAH TURNER 

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The day that financial adviser Charles Moore of Koda Capital had been expecting for 11 years finally arrived this week with a sharemarket drop steep enough to enter the history books.

Investors could only look on in horror as the S&P/ASX 200 plunged almost 8 per cent in one day, the sharpest drop for the benchmark since the global financial crisis.

The selloff took place at an extraordinarily rapid clip, compounding losses made since the benchmark's record high on February 20 to more than 25 per cent. The ASX 200 is now in a bear market – which signifies a 20 per cent fall in the market.

But Moore, who manages between $750 million and $800 million of money for clients with an average account balance of between $12 million and $15 million – reminds clients that big moves are all part of being invested in the markets.

Measured approach

"The one thing that we can't control is that these episodes are going to happen. The quicker we accept that and build a strategy to withstand them, the better placed we are," says the adviser and partner.

This measured approach is the pay-off from spending the years after the GFC devising strategies to manage such a market shock. Preparations include everything from near role play with clients to setting out specific action plans for investing through a crisis.

"We are investors for the longer term, we build portfolios that are hugely diversified and we don't make short-term panic decisions because things that we ultimately expect are going to happen from time to time materialise," Moore says.

"Historically the least successful long-term investors are those that try to time market crashes."

Preparation can only go so far, however, he acknowledges.

"Clients will often tell us that they have a high-growth investment objective and a high tolerance for risk," the adviser says. "But when they are confronted with a 20 per cent decline in equity markets, that risk tolerance can change very quickly."

"In 2008-09, some clients who didn't really have a strategy rode the tide of the market as it was going up and didn't have a plan for what they were going to do when it went down.

"A lot of them held on, and held on, and held on but when the market got down to 3200 points in March 2009, that's when they said 'I can't take any more' and sold. Many of those investors have never put any money back into investing."

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Rome's Colosseum wears a deserted look. The coronavirus cases are falling in China and South Korea but are spreading rapidly in Europe and the US. Bloomberg

Investors burnt by losses in this week's crash into a bear market may be considering cutting their losses, especially in equities.

But Sue Dahn, executive director and investment adviser at Pitcher Partners, who manages between $5 million and $10 million per client, says she's telling clients not to sell into this market unless they really have to.

"It really is a case of rationality has left the building. Markets are being driven by fear and uncertainly and irrationality and there is just too much selling pressure," she says.

Investors need to remember that they are not speculators looking for a quick price-only return but in markets for the longer-term and should do a portfolio health-check to determine whether they are getting the income they require, she says.

"That applies whether you’re a charity, a university or an SMSF."

The adviser warned that market turbulence may continue and investors may see capital losses this year. However, as long as portfolio income is correctly matched with requirements, then investors should feel "quite satisfied with that, knowing ultimately that they will get through this".

"None of us know with certainty how long these things last but from being around in 1987 and 2008, we know these things do pass. It feels like an I shape at the start, then it becomes an L because markets have hit some kind of floor. In the fullness of time, it becomes a U.

"This won’t be a V because the events are too large. The world authorities are doing what they can with accommodative monetary policy and fiscal stimulus," she says.

"It feels much more like 1987 than 2009 to me," Dahn says. "In 1987 we had a crash that was a crisis of leverage but in the GFC we had a structural crisis of the banking and finance sector. The financial system had broken and was rescued from the brink.

"The system isn’t broken now. It's an unexpected crisis that is having unknown economic consequences. The market is reacting properly to uncertainty. It's doing so in a largely orderly fashion.

Different cycles

"It's trying to figure out what’s going on, which is impossible. How much impact is the virus ultimately going to have on the world economy? Is it temporary or is it long-lived?

"This is much more like 1987 and therefore much more likely to be a matter of months not years before it finds the inevitable floor and then a U-shaped recovery," Dahn says.

Alex Wolf, Asia head of investment strategy for JPMorgan Private Bank is also expecting a U-shaped recovery rather than a V-shaped recovery for the global economy, noting the progression of the Chinese economy back to normality has been slower than expected.

The virus has different cycles, he notes, with cases now falling in China and South Korea but spreading rapidly in Europe and the United States.

This is likely to prolong global economic weakness, he says. "With the two largest consumer markets in the world now facing much weaker demand, China can turn on the factories but they are not going to have anyone to buy their products."

Wolf also says it's too late to start selling shares in response to the market carnage this week. "Unless you derisked two weeks ago, you don't want to be selling now."

He says the nature of the investor panic has made some areas of the market more dangerous than others. For example, the energy sector is high-risk, with Russia and OPEC engaged in an oil stand-off.

"There is also a lot of uncertainty over travel and tourism companies such as airlines. hotel operators are cruise lines." Investors looking back at the terrible events of September 11 in New York may recall that "9/11 did some lasting damage to the airlines".

Wolf says the wild swings in markets stem from investors trying to grapple with three simultaneous shocks. They are dealing with a negative supply shock and a negative demand shock from the virus and now an oil supply shock, he says. "Investors are still coming to grips with what it means."

Interest rates have forced investors out along the risk curve. 

Charles Moore, Koda Capital

The progression of the virus will be key for economic growth and markets, he says. "As long as it fades in the second quarter or third quarter, we should get a bounce back," Wolf says. As the virus is an external event rather than an internal economic imbalance, "there's pent-up demand and there tends to be a quicker snap back."

Portfolio construction is crucial to act as a buffer in times of crisis, says Dahn. A good portfolio is one-third exposed to listed equities, one-third exposed to defensive assets such as cash and bonds and one-third exposed to real and unlisted assets.

"You will be sustaining some damage on the listed equity side. We have all seen that but you will still generate income from your portfolio," she says, noting that equities may be taking a hit but bonds are at record highs.

Moore says it could be worth double-checking portfolio diversification. Investing in shares in five different countries isn't diversification, for example, he says.

"They will be heavily correlated," he says. Similarly, a strategy of investing in Australian banks, hybrids and term deposits "is all the same trade," the adviser says.

"At times of market stress, the investments that suffer the most are the ones that investors passively put money into."

Investors wanting to exit sharemarkets, as well as baking in losses, face the problem of where to put their money.

Returns from cash have dwindled along with official interest rates while bond yields are on a downward path – 10-year government bond yields in Australia hit record lows this week.

Moore hasn't held government bonds for five years as he worries that capital gains in bond markets are unlikely to last.

"That might have cost us some return but we have found return in alternate sources. If bonds have delivered a 10 per cent return but only 1.5 per cent of that has come from income, that's unsustainable," he says. Similarly, he doesn't own any US equities and hasn't done for 18 months.

"We have two investments in our portfolios in China. They were positive in the month of February. They are unlisted funds managed in mainland China by Chinese locals. They are multi-strategy funds that make long-short investments."

The very low-interest rates that have worked through to cash and fixed income are also part of the equity story. Lower interest rates can justify higher valuations by changing discount rates if investors believe rates will remain low for a long period of time.

"There's no doubt that interest rates have forced investors out along the risk curve," says Moore. "Significant events like this will lead to repricing.

"I think in that sense investors will re-evaluate what they are investing in but if interest rates continue this low for another couple of years, then I think that good quality companies with good balance sheets paying dividends that are greater than the cash rate – they will come back into favour," he says.

"Over the longer-term, investors can use this as an opportunity," Wolf says.

Clients may consider companies that pay higher dividends and are of higher quality. "From a yield perspective, we are looking more at real assets such as infrastructure and real estate.

"We don't know how long this will last but we feel certain that it won't be forever," Moore says. "We've held off deploying cash for clients into equities probably now for six months. For those clients that have no cash in equities, we might now put some in.

"Is today the day to buy the market? I don't know, but it's significantly cheaper than it was three weeks ago. I think that when you have these episodes, buying something is a good idea but not spending all of your money in one day thinking that you might be the hero that picked the bottom."

Dahn is much more optimistic about the markets after the drop of the last few weeks.

"The margin of safety is much greater if you are buying good income-paying, earnings-generative, high-quality stocks in this environment. It's much more attractive than a month ago.

"You might choose – given how much more inevitable recessionary conditions are across the world – to think about buying securities in sectors that are defensive. By that I mean you would probably be looking at consumer staples over transport for example.

"The cyclical sectors might be best avoided. Instead, investors might look at the kind of sectors that you need regardless of whether the economy is growing or not."

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