Preparing for a post-Covid-19 world

The man-made economic slump which resulted from the global health crisis is an event that hardly anyone could have predicted. After more than a decade of bull markets, investors suddenly woke up to a radically new situation, wondering if policy makers, asked to come to the fore again for an ultimate rescue mission, would be able to pull it off.

Like in previous crises, shock and awe has often stopped money managers in their tracks, preventing them from acting efficiently.

The Covid-19 crisis was indeed an ‘excellent test’ to prove the power of fund management discipline and revealed what flexibility really means when it comes to managing risks, explains Didier Saint-Georges, a member of the Strategic Investment Committee at Carmignac.

‘Flexibility is written in the prospectus of most funds, but surely when you have this kind of fat-tail event, then being truly flexible is mandatory. It’s not enough to just put it in the prospectus,’ says Saint-Georges.

The financial crisis of 2008, a major internal shock stemming from imbalances in the banking system was brilliantly navigated by Patrimoine, Carmignac’s flagship fund, thanks to its risk management discipline. Yet, the crisis of 2020 was of a totally different nature, unfolded in a market environment where the role of central banks was already predominant, and in a vastly more globalized world, with China a having a much wider influence.

The lack of understanding of this crisis caused many investors to both badly suffer from the initial huge sell off and miss the ensuing market recovery. By managing risks and sticking to its convictions, the Patrimoine fund outperformed 97% of its peers in the Morningstar Moderate Allocation category as of the end of June.

Very early on, the team reduced the exposure to peripheral bonds and to emerging market debt, cut drastically the net equity exposure through futures contracts to hedge market risk and increased its cash holdings. But the fund remained focused on its secular growth names and avoided any value traps or sensitive sectors.

’That’s what we did in 2008 and in 2011: we cut the market risks but stick to our convictions. The difference between the two if the stock selection is right is the alpha generation,’ says Saint-Georges.

Since the end of March, the fund has opportunistically added some high-quality cyclical names that stood a good chance to recover quickly after being hit hard by the pandemic, such as in the travel industry.

But the backbone of the equity exposure of the fund remains focused on high-quality secular growth names which have kept outperforming market indices during the height of the crisis. These names are found in a wide range of sectors across regions, but in particular in the healthcare space as well as Tech-related sectors well-suited to ride long-term themes such as digitisation, the connected consumer and demographics.

On the credit side, the fund acquired some names where the default risk was, in our analysts’ opinion, overpriced by the market. In this area of the market, the crisis accelerated the business cycle, creating dislocations between sectors and value dispersion, and offering more opportunities for bond pickers, Carmignac notes.

So, what’s next for Patrimoine’s strategy? The key message is open mind.

For the time being, the unprecedented support from policy makers is helping consumer spending to recover quite well, except in some battered sectors. This dynamic together with direct interventions from central banks on financial markets is supporting equity and credit valuations. But the jury is still out on the prospects for future private-sector investments given the level of uncertainty. And epidemiologists themselves can’t tell what the shape of the Covid-19 contagion map will be in the second half of the year, nor can economists predict what its impact will be on consumer and investor confidence. Therefore, the next months are being addressed with a lot of vigilance.

On the geopolitical front, tensions between the US and China are unlikely to ease anytime soon but making predictions in this field would also be very presumptuous as active campaigning for the US Presidential is really only starting now. By the same token, the fiscal policy to be implemented in the US next year is highly uncertain today, Carmignac believes.

For once, the economic recovery might prove more robust in Europe, a region where the team shows confidence, than in the US as the old continent was more effective at bringing the pandemic under control before reopening its economy.

When looking at the potential shape of the recovery, Carmignac believes the consensus for 2021 at the moment might be ‘way too optimistic’ says Axelle Pinon, equity product specialist manager at the fund group.

The firm’s base scenario is a U-shaped recovery but the group is also considering a more negative L shape.

‘We will be more tactical in the coming weeks,’ says Pinon, ‘but in terms of the structure of the portfolio, we are very confident in our equity portfolio focused on secular growth stocks. We have been active during the crisis and we were able to buy stocks from our watch list that offered more attractive valuation.’

‘If we have a big market sell-off coming, we can go back to zero in terms of equity exposure, if needed.  We are not afraid of doing that,’ she says.

‘This is a period when you have to be very disciplined in your investment process, because mistakes are very expensive during a crisis,’ says Saint-Georges.