Three key considerations for trustees on coronavirus

The coronavirus outbreak is the latest in a myriad of risks to have challenged the investment environment over the past 18 months. From US-China trade tensions, to Brexit and the upcoming US election, pensions funds and their advisers are having to work harder than ever to distil the portfolio implications of the rapidly evolving risk backdrop.

The virus is already a truly global crisis, perhaps the first since 2008, and the medium and longer-term impacts are – and will remain – incredibly difficult to evaluate.

As trustees assess the potential ramifications of coronavirus for portfolios, we believe that three key considerations should rank high on their agenda.

The OECD’s downgrading of the global growth outlook may provide some indication of the scale of the challenge ahead

Eoin Murray, Federated Hermes

The first is equity market positioning. After a torrid couple of weeks for global stock markets, it is crucial for investors to maintain perspective on both current valuations and the outlook for risk assets from here.

Since the global financial crisis, investors have enjoyed a period of incredible returns for equities, and the recent sharp corrections have simply moved levels back to those seen as recently as October last year.

The downturn has felt dramatic, but major equity indices remain at highly elevated levels despite the speed and scale of the sell-off. Crucially, we should not assume that prices shown across markets two weeks ago, when tail risk seemed to be meaningfully underestimated, were correct, and what we see now is wrong. For investors with a longer time horizon, opportunities will present themselves.

Credit market pinch

Liquidity is another consideration for schemes, particularly in credit markets. The high-yield market reaction has been more severe compared with equities, with the biggest moves for the asset class since 2011, in part due to overheated valuations in this part of the market.

Energy, financials, autos and retail have borne the brunt of the reaction so far, with, broadly speaking, the biggest moves seen in areas that have been easy to sell. As a result, there may well be further declines in less liquid areas of the markets if the current high levels of uncertainty endure, and trustees must think carefully about the shape and scope of exposures. A deep understanding of long-term value will guide pension investors to the greatest opportunities.

The outperformance of emerging market credit through the broader sell-off has been quite notable despite the volatility.

From a regional perspective, Asia has been outperforming both Latin America and Ceemea (central and eastern Europe, the Middle East and Africa), in part due to market decompression, with investment grade outperforming high-yield credit.

Third and perhaps most significant of all, the US Federal Reserve’s emergency rate cut and stimulus packages from central banks around the world – headlined perhaps by the Bank of England and Rishi Sunak’s one-two monetary and fiscal punch – should be a key marker for pensions funds’ near-term expectations for interest rates and, by extension, scheme liabilities.

Central banks taking action

March began with a global rebound triggered by investor hopes that central banks’ intervention to counter coronavirus-inspired correction, but the Fed’s fairly drastic 50bp reaction seemed particularly precipitous given the limited clarity on the virus impact on both US inflation and the nation’s labour market. 

The latest moves also underscore the reality that central banks have limited firepower. From a global perspective, while monetary easing can offset the tightening of financial conditions following equity sell-offs, in isolation, such moves are not an effective response to the supply and demand shock that coronavirus, and plunging oil prices, has given rise to. 

Through the coming weeks and months, trustees and advisers may face a perpetual battle between hedging risks and seeking returns. It will be important for investors to maintain perspective on both equity and credit valuations, while ensuring that strategic positioning remains aligned with schemes’ investment horizons. 

Coronavirus may not be ‘cured’ in the next six months, but in view of the fact that many pension funds are positioned for the next three, five, 10 or even 15 years, trustees must maintain an appropriately long-term perspective as they navigate their schemes through the outbreak.

In our view, climate change still presents the most significant long-term challenge for us all.

Eoin Murray is head of investment at Federated Hermes