Strategy Update

Chris Brown, CIO, 22nd April 2020

The current fight against the corona virus does indeed feel most like a war to us. The lesson of history is that wars always start with the participants expecting a quick victory, low casualties and everyone home by Christmas. In reality, the length of the campaign and the cost – in human and economic terms – turns out to be far greater than anyone thought possible going into it. Having rallied sharply off the March lows, equity markets look like they are positioned today for a short war. We remain more cautious and are ready for the economic and financial impact of the virus to drag on for longer than many expect. This may mean we are due a second bout of volatility and losses in the summer or autumn this year.

That said, we are not positioned particularly defensively today and, as we explain below, we have been selectively adding some risk where we see opportunities following the March market rout. Why is this given that the economic impact of the virus might last for the rest of the year or longer? Our main reason is that, as we have written before, there are just too many unknowns today to make firm predictions about will happen next. To name but a few, we don’t know the true the nature of the disease itself, the risk of a second wave of infections and lockdowns, the impact of central bank and government support programs to cushion the effects of the slowdown, the longer lasting changes in behaviour this event will trigger or how long vaccines and treatment drugs will take to appear. All these will meaningfully impact corporate profits and so market prices.

This means we can’t predict the next 12 months with any kind of certainty. We can, however, fall back on our advantage of having a longer term time horizon. This means we are focussed on participating in the recovery when it comes rather than the (shorter term) goal of avoiding short term price swings. Though this is like a war, it is a war we will eventually win. We think longer term investors should be positioning themselves today for the eventual victory, though it is far from clear today how long this will take or what the final human and economic cost will be.

We therefore remain on the look-out for opportunities. One area we continue to like is bank credit. In 2008 banks were a major part of the problem. Today they look to be a key part of the solution with many of the government support packages running through the banking system. Banks also went into this crisis in a far stronger capital and liquidity position than in 2008. We added our first bank credit focussed fund this week and are continuing to look at that and other credit focussed opportunities. That said, given our general sense of caution we are also keeping some dry powder available in case we see further market falls and new opportunities do not arise.

One opportunity we have looked at and rejected, however, is an investment geared around going long oil. The obvious trade today is to buy oil (which has even traded below zero in the last few days), wait for the price to go up, and then sell it sometime next year. While this is, in theory, a trade that will make money, the problem is that the world has run out of storage. Oil tankers and the other storage facilities are full. (You could buy some barrels and stick them in your garage of course but driving to Aberdeen or Cushing Oklahoma is not free!) This means that although oil is priced at $13 today and is expected to be $30 next year you cannot profit from this difference today. Oil ETFs, which have been tempting many retail investors looking to make a quick buck, cannot escape the storage problem and so have continued to take losses not helped by the money flooding into them pushing prices well above the level of true demand today. For today at least, oil remains an area for us to avoid.

We will keep providing regular updates like this, but please do get in contact with us if you have follow up questions or there is anything you want to discuss in more depth.