There is little doubt that the first quarter of 2020 will go down in investment history as a ‘notable’ period that investors will remember, alongside others such as Monday, October 19, 1987 (‘Black Monday’) when US markets fell by over 20% in one day and the Global Financial Crisis of 2008-2009.

It is notable more for the cause of the market fall, being the instant shut-off of revenues for many businesses around the world on account of the global lockdowns in place, rather than the magnitude of the fall.  After a rebound in April, global developed markets are only down a little over 10% in GBP terms so far this year.  High quality, short-dated bonds have held their value.

It is interesting to note how UK investors have been behaving over this period.

1.     The move continues from active to passive funds

For some time now, there has been a flow of investors moving out of traditional actively managed funds, where managers promise to beat their market benchmarks, into passive funds that seek to deliver the return of the market as closely as possible.  Recent data ([1]) reveal that in Q1 2020, UK investors withdrew only £0.5 billion from equity funds as a whole, compared, for example, to withdrawals of £4 billion in 2016 on account of Brexit uncertainty (doesn’t that feel a distant memory now!).  Digging a little deeper also reveals that in Q1 2020, £2.8 billion was withdrawn from active equity funds and £2.8 billion invested in passive, index-tracking equity funds by UK investors, most of which occurred in February and March.

2.     UK investors sold out of bonds on a huge scale

The same data set reveals that in March 2020 investors sold more than £3.7 billion of bond assets.  It is possible that, in part, this could be due to investors rebalancing, but it is more likely that lower credit quality bond prices have been severely hit as yields have risen (and therefore prices have fallen) and many investors have fled to higher quality bonds, or cash.  It’s no surprise that government bonds have fared well.  A similar story has unfolded in the US, but on a far larger scale ([2]).

Figure 1: Flows over time into bonds and equities by UK investors

[1] https://www.calastone.com/covid-crash-caused-record-fund-outflows-and-a-bond-rout-in-march-while-passive-equity-funds-saw-unprecedented-inflows/

[2]     Asset managers rocked by record bond fund outflows. 19 March 2020. https://www.ft.com/content/30e8928e-6a33-11ea-800d-da70cff6e4d3

3. Absolute return funds have fared poorly

It is always tempting to believe that professional fund managers have the skills to be able to protect investors from market downturns. It is the raison d’etre of absolute return funds to protect capital. As you can see below, strategies that seek to pick up pennies in front of a steamroller usually have some hidden risks! This sector as a whole suffered a peak-to-trough fall in March of 9% or so. Absolute return? Absolutely not!

Figure 2: Absolute return funds have failed to deliver on their promise

What does the first quarter of 2020 tell us?

Perhaps more than anything else, the insight that we can glean from the first quarter of 2020 is that risk and return are related.  Searching for additional yield on bonds exposes investors to risks that come back to bite them when the markets are scared.  That is why Wells Gibson focuses predominantly on higher quality bonds in a portfolio’s defensive assets.

We can also see that active fund manager promises are hard to keep, which is why we prefer highly diversified systematic approaches to the more traditional judgmental approaches of most active managers.  Many others seem to agree.

At Wells Gibson, we continue to advocate the following four sensible steps to owning an authentic investment portfolio:

  • Build a deeply diversified portfolio.
  • Let capital markets do the heavy return lifting.
  • Hold onto your returns for dear life.
  • Undertake some basic portfolio maintenance.

We don’t know what tomorrow might bring in the markets, but we should feel confident in the construction of our portfolios to tackle what might lie ahead.