When the markets enter sales mode, few stocks are saved and then the differences return, for example between more and less volatile stocks or between growth and value. But for active managers it is not easy to beat index funds and sustainability is increasingly becoming a winning theme.
The global collapse of the markets caused by the Coronavirus epidemic has been rapid and violent: March 2020 will be remembered by financial operators as the month in which investors, governments and central banks have faced unprecedented situations. But what can be the keys to understanding what has happened for those who have no speculative intent? Morningstar has identified five.
Performance of passive funds better than active funds
For active equity managers it was difficult to beat passive instruments in the first quarter of 2020, although exceptions were not lacking. Morningstar Investment Management (MIM) analysts have calculated that growth-oriented strategies have on average managed to yield higher returns than the corresponding index funds in the first quarter of 2020 in different categories (Europe, USA, global). By contrast, active value equity funds did worse than passive funds (and not a little, see table below). The main reason, analysts explain, is the continuation of the trend seen in recent years, characterized by an underperformance of the industrial and financial sector and by strong increases in the large technology companies. Active managers on average also produced negative excess returns on emerging and Asian equity markets, including Japan, although there were those who managed to generate value for their underwriters.
In some niche areas, active managers have distinguished themselves from passive ones. Often these are segments where the offer of index funds is contained, such as Russia equities, the financial sector or indirect real estate (Reit, real investment trust). In these cases, fund managers have shown that they know how to protect investors more from falling prices.
The non-return of value securities
Perhaps some value-oriented equity managers were hoping for a return to the popularity of value stocks during the stock market crash. But it didn’t happen. Growth-oriented companies and managers oriented towards this style of investment performed better. One of the main causes is the sharp fall that has affected some important value sectors, such as oil, basic materials and financials.
There are now fund managers and commentators who believe that growth stocks will recover even faster. “The financial strength of these companies will continue to attract investors who are looking for security, since we are in an extremely uncertain period,” say MIM researchers. “It should also be noted that the dimensional factor did not significantly influence the dynamics of returns”.
High volatility markets
When the idea of selling everything prevails on the markets, few are saved. It also happened for low volatility securities in the first phase of the stock market crash, however, subsequently low volatility instruments performed better than riskier ones, which are generally associated with situations of financial stress.
Investors in equities must however also take into account the earnings revision, which has been the largest since 1974, even exceeding that of 2008. “The market has quickly moved towards a pessimistic short-medium term vision on economic growth and of profits, with the prospect of a recession now inevitable” comments MIM.
Then there is the cancellation or postponement of dividends in different sectors. In Europe, for example, many banks are following the recommendations of the ECB in this regard. Various utilities (utilities) are doing the same for budgetary reasons or political pressure. As for the latter sector, Tancrede Fulop, Morningstar equity analyst comments: “These decisions create disappointment, because stable and growing dividends are a key element of utility investments. In addition, the sector is less influenced by Covid-19 than other industries, such as the oil industry, which would appear to intend to maintain coupons”.
ESG (Environmental, Social, Governance), a winning topic
The Morningstar Global markets sustainability leaders equity index did better than the traditional one in March and also over longer horizons. “The two benchmarks are comparable because they have a similar factorial exposure” reads in the MIM study. “We can therefore say that environmental, social and governance (ESG) factors have generated value on equal terms with other conditions”. This trend has also been seen regionally in Europe, the United States and Japan.
“Even more encouraging” the researchers continue, “is the potential that the most virtuous companies have from this point of view to participate in the recovery when there is”. In the United States, investors are beginning to consider the long-term impacts of the epidemic and therefore the sectors that could benefit from it, such as automation or remote work. In some cases, the changes will bring benefits in terms of sustainability, such as less pollution resulting from the fact that workers move less, using different solutions.
Beware of spreads and liquidity on the credit market
It was also a difficult first quarter for specialized credit bond funds. In the high yield segment, that is the riskiest issues, the period will probably be remembered for the fast and large sell-off, rather than the widening of the spreads which still remains below the maximum of 2,000 basis points of the great financial crisis of 2008. The US market was the hardest hit with differentials above 1,000 basis points on March 20 and an expected default rate that was priced around 10%. The euro high yield segment suffered less thanks to the lower percentage of very low rated securities (B and CCC) and the lower exposure to the oil and natural gas sector.
Liquidity was another central issue on the global credit market and was seen above all in the differences between the market prices and the Navs of the dedicated ETFs. “On March 12 the most extreme point was reached, as can be seen in the graph below of one of the largest ETFs in the world, the Vanguard Total bond market, 55 billion dollars under management, which on that day recorded a rate discount of -6.2% ” reads in the MIM report.