It is two years since the Covid-19 pandemic. The worst health crisis the planet has experienced in this century, which has left behind almost six million dead and more than 500 million people infected. On 11 March 2020, the World Health Organisation (WHO) declared the coronavirus a pandemic, marking a turning point in our lives. Around mid-end of March of 2020 all the European countries started to shut down, non essential shops were closed as well as cinemas, restaurants or venues. The companies switched to work from home when it was possible, and the European Central Bank, with the support of the members of the European Union approved the Pandemic Emergency Purchase Programme.
Beyond the personal impact that the pandemic has left on each of us, investors had to deal with sharp falls in the markets during the first weeks. If the coronavirus has made one thing clear, it is that investors need to be more prepared for future black swans. So we wanted to find out what investment lessons asset management industry professionals have learned from the past two years.
Sandy Black, Chief Investment Officer, Polar Capital
The end of February 2022 marks the two-year anniversary of the sharp falls in equity markets, and correspondingly significant rise in bond prices, which accompanied the initial, rapid spread of Covid across the world.
This two-year period has been an interesting experiment in the adaptability of humans, both in their personal and professional lives. We have all had to deal with changes in patterns of work, home life, education, leisure and travel. Reassuringly, we can conclude that our species has the resilience and flexibility to survive in unforeseen and threatening circumstances, but whether the adaptations which we have all made are optimal from a long-term perspective is a more difficult question to answer.
Even prior to the outbreak of Covid, many businesses had begun to introduce more flexible working arrangements. Firms had already acknowledged the ability of technology to facilitate work from locations other than a central office. The lines between ‘work time’ and ‘home time’ had already softened, giving individuals greater choice. Companies that had implemented these changes were in a better position to move fully to the work from home requirements of the early phase of Covid.
Investment management as an industry is a good candidate for these more flexible working arrangements; it is superficially easy to relocate human capital and to recreate work networks in virtual form. Financial markets recovered quickly from the initial period of high volatility, with trading volumes reaching record levels in the second half of 2020.
Successful investment depends however on good long-term decision-making which, in many investment organisations, means bringing together small groups of people with different specialisations. Not much in investment is black and white, as success relies on an ability to assess the future; even the very best fund managers do not get much more than sixty percent of decisions right.
As time has passed, more and more investment teams have observed the shortcomings of virtual communications. Face-to-face meetings tend to be more interactive, and better at capturing the various small building blocks which contribute to an investment decision. While the ebb and flow of in person communication can incorporate the most basic observations, some people feel that, in order to initiate a Zoom or Teams call, you need to have something ‘big’ to say. The hurdle is higher, so some judgements can get missed.
Many humans have a tendency to extrapolate observable trends when making assessments about the future; this is not a bad rule of thumb when forecasting, for instance, weather patterns, and often in investment, but it does not work all the time. One of the dangers during Covid was assuming that the rapid changes in working patterns and technology adoption in mid 2020 would be permanent. The popularity of Delivery Hero and Zoom led to rapid share price gains relative to broader markets. However, their speed of business growth, at least in the short term, was not maintained, and their share prices have declined.
In this regard, the pandemic has been a valuable reminder of the many uncertainties in investment. Those businesses which already had flexible working arrangements have benefited, those that did not have introduced them, but our experience at Polar, from a position where many fund managers, even pre Covid, spent some time working from home, is that collaboration in the office still has an important role to play in navigating an uncertain world.
Johanna Kyrklund, Global Head of Multi-Asset Investments at Schroders
Despite brief respites of normality when infection rates start to fall, the current crisis is far from over, Besides, the pandemic forced governments to put stabilisers on the “wobbly bicycle”, allowing us some reprieve from cyclical volatility. Those stabilisers will be coming off this year and the private sector will have to take on the baton of growth.
This scenario demonstrates that we live in a changing word. In the past 25 years my focus has always been on the interest rate cycle but arguably, going forward, the pricing and regulation of carbon as well as the broader shift from fossil fuels to sustainable sources of energy will be just as fundamental to market performance.
Looking at our models, we are now entering a more mature phase of the economic cycle when growth momentum peaks and central banks begin to withdraw support. Against this backdrop, we expect equity returns to be more muted but still positive, supported by solid corporate earnings.
Inflation is a popular theme, and we would agree that over the medium term we are likely to be in a more inflationary environment compared to the last decade. This is driven by rising wages, deglobalisation and decarbonisation. In the shorter term, we expect inflation momentum to peak as supply bottlenecks ease, but central banks will still raise rates.
At the stock level, it is important to identify those companies with pricing power given the risk to margins posed by higher input costs and wages, as these will be better placed to weather the storm. However, we do not believe that inflation poses a systemic risk for markets yet as the willingness of central banks to start raising rates in response to inflationary pressures should help to mitigate any sell-off at the long end of government bond yield curves.
The one area that could surprise is China where, unlike other major economies, policy is turning stimulative. At the same time, rising rates will put pressure on the frothier parts of the market, prompting rotation and volatility. The times they are a-changing, opportunities remain but the ability to be flexible and nimble will be key. In more simple terms, diversify your risk – this is not a time for big bets.
Thomas Hempell, Head of Macro & Market Research at Generali Investments
It is hard to exaggerate the historical dimensions of the Covid pandemic, an event that thus far has cost almost six million lives and suffering among more than 400m infected people globally. It has tiggered the deepest global recession since WWII, one of the strongest recoveries and a lasting impact on workplaces, social interactions and economic relations. From an investor point of view, three lessons stand out.
First, Covid is a reminder that investors need to prepare for more frequent black swan events in their long-term return expectations and risk management. In a globally intertwined world, international supply chains and global travelling allows disruptions (from diseases, geopolitical tensions, etc.) to turn into global issues more quickly. Going forward, this is especially true for climate change, which raises the risk of natural disasters with wider impacts on migration and geopolitics. Moreover, the tight web of global IT systems and software enhances global cyber vulnerabilities that may turn into systemic risks.Second, crises are opportunities for contrarians if the deep pockets of governments and central banks are on their side. Policy makers have made strong progress in coping with deep global recessions.
Unlike in the 2008/09 GFC and the European debt crisis, governments and central banks acted swiftly and boldly during Covid. This has helped the global economy to rebound much faster from the 2020 slump than markets and economists thought, even if at the cost of soaring public debt. Global equities have almost doubled from their March 2020 troughs, to the profits of contrarians buying during sell-off episodes.
Third, for structural breaks, the supply side matters.
Business cycles are dominated by swings in demand, and that’s where most analysts are focused on. In the wake of global disruptions, however, investors and economists need to appreciate more strongly shifts in the economy’s productive capacity and their implications for assets. Inflation, for example, is set remain elevated more lastingly in the post-Covid world, as the disruptions from global supply chains, changed preferences (incl. the ‘great resignation’ of workers) and labour mismatches are ending a decade of low-flation. Climate change adds to price risks, due to the costs from a higher incidence of natural disasters and from mitigation policies (incl. carbon pricing). A structural revival of inflation also means an end of the three-decade era of low and falling yields.