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The following Q&A is between Hub CFO Jonathan Chevreau and Multi-Asset Portfolio Managers Ian Riach & Michael Greenberg of Franklin Templeton. (Franklin Templeton is a Hub sponsor.)
Jon Chevreau: The last few months have seen unprecedented volatility in the markets. How have your portfolios been impacted in this recent drawdown?
Mike Greenberg: Given the speed and severity of this downturn, our Portfolios from an absolute return perspective have been challenged like many others on the street. However, we do believe the current environment and positioning should allow strong returns going forward. We see a scenario similar to 2008 where balanced products suffered, but then rebounded very strongly. We can’t be sure of timing but feel same play book is a realistic expectation.
However, on a relative returns basis, our portfolios have performed better than some of our competitors. This is due to the more defensive positioning we took before the bear market started, where we reduced risk based on what we believed were stretched valuations in a late cycle. We had also reduced credit risk earlier, as we felt risk/reward was not favorable given the spreads. Especially in Canada given the threat of potential illiquidity with some assets. Despite not anticipating the crises, having a lot less credit exposure compared to some peers, worked out very well for us. Within our equity fund selection, we had previously moved more into our core funds, which have held up well in the downturn given their quality bias. We also increased allocations to some of the lower-beta funds/ETFs funded from more cyclical holdings that had more value and small cap bias.
Jon: What effect has this volatility had on your fixed-income allocations?
Mike: There are not many places to hide even in fixed income, as credit and spread products really sold off. Still, being more conservative and selective in our fixed income exposures prior to the downturn has helped us weather the storm quite well. We also feel we are well set up for some good opportunities in fixed income going forward.
We’ve been adding incrementally to credit funded from governments and we see better opportunities in credit but there is still some risk so we are not going ‘all in’ quite yet. We anticipate corporate earnings will crater and bankruptcies rise in the upcoming months. The longer the virus containment goes on, the larger the risk to the global economy, so we are being selective about picking our spots. Given the uncertainty we favour more active exposures in fixed income; even the fixed-income ETFs we hold in our portfolios are more active, and for us, that is important going forward as we are looking to capture some of the opportunities.
We are now a bit more positive on credit, especially in investment grade credit in the US given direct support from the Federal Reserve. Canada has seen some quantitative easing measures, but not direct corporate bond purchases like the US, so we still view this as a very illiquid market in Canada. So, we are bit more hesitant in that space, but we are also aware that there is a tendency to throw the baby out with bathwater, which again highlights why we like active credit management in this space.
Jon: Where do you think the Loonie is going?
Ian: I think the Loonie will continue to remain relatively weak compared to other currencies due to a number of challenges. The Canadian Dollar has been influenced by the economic backdrop of course but also energy prices. The influx of supply from Saudi Arabia and Russia combined with the forecasted decrease in demand due to Covid-19’s effect on the global economy has sent energy prices into a free fall. Canada is feeling it even worse than others. Just a few weeks ago when West Texas Intermediate oil was close to $50/bbls, our price benchmark Western Crude Select (WCS) was around $35 but recently we’ve seen it trade less than $5.00/barrel which is absolutely devastating for parts of our economy and our dollar.
Given the Loonie’s relationship to the oil price it is no surprise we have seen it drop and we feel it could stay weaker until we see some uplift in oil prices. Right now, we believe that current prices are not sustainable for anyone, Saudi Arabia included. They can likely produce a barrel of oil for somewhere around $10 – $11 per barrel, but really, they require oil prices to be around $60-$70 a barrel to balance their budget. Recently we have seen an OPEC deal that will attempt to curb supply to bring better balance to the market, but the demand hit will be large.
That is why we would not be surprised if we see a recovery in energy prices soon, and that will help the Canadian dollar somewhat, but the general economic backdrop of Canada will still keep our currency at low levels compared to the US dollar even in the recovery.
Jon: How will this downturn impact Canada’s commercial and residential real estate markets?
Ian: It will have an effect on both markets. On the commercial side, probably the hardest hit will be hospitality related properties like hotels, restaurants, coffee shops etc. Small office complexes with various service industries will also feel the lack of rent coming in and may face re-leasing problems if certain businesses can’t reopen or chose more remote working arrangements. Industrial properties will probably rebound quicker as the economy starts growing again as physical plants and storage are required for manufacturing and there could be pent up demand building right now.
On the residential side the effects may be shorter term in nature: people can’t decide to live “virtually,” they need a physical home. In the short-term buyers may be hesitant to make a move from rent-to-buy or “move up” due to uncertain employment situation. Sellers, unless they really need to move, say because of work, may be reluctant to accept offers that they feel are below “true value.”
Prices may dip in the short term as forced sellers may have to accept price concessions at least until there is more economic certainty. It also depends on what area of the country we talk about. Major urban centers like Toronto where supply had been limited before the downturn will likely see activity rebound more quickly than in areas like Calgary where the double whammy of the virus and the collapse of oil prices will affect that city more acutely.
How do you see Covid-19 affecting the economy and how would a recovery play out?
Ian: Obviously Covid-19 has already had a big impact on the economy and there remains many unknowns before we start to see a lasting recovery. We don’t know what letter in the alphabet the economic recovery will look like: a “V” or a “U” or “L” as the recovery is so dependent on the virus and the news on that front is still evolving day-to-day.
If we had to pick one now, I’d say we are looking at a “U”: the resolution of the virus will take longer and its impact lasts longer than expected, thus the rebound starts but with lower force and is more drawn out. In fact, it will probably look more like a “W” and we mean a true double “U” not a double “V” like we use conventionally when we write or type. Meaning we get a low and slow recovery, that will likely include fall backs. So it will likely look more like a sine wave than a letter.
Given this view we have been reluctant to aggressively add risk to the portfolio, although we have been adding on a measured basis as the outlook for equity returns over bond returns are much more attractive 12-18 months out. One positive note has been the significant policy responses from governments, which should help soften the blow.
What do you think about all this money printing by the Fed and other central banks?
Mike: The amount of money injected into both economies has been as unprecedented as the market shock itself. Continue Reading…
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