Coronavirus is first and foremost a health issue. However, it’s also a timely reminder that investment risks always exist. The strong market returns of the past decade may have caused some investors to forget this.
Natalie Comino: Welcome to our special update on managing investment risks and the coronavirus. My name is Natalie Comino. I'm a portfolio specialist at MLC Asset Management. And I'm joined by Al Clark, our Head of Investments. Welcome, Al.
Al Clark: Thanks, Nat.
Natalie Comino: Concern about the coronavirus is sweeping the globe. What's the latest?
Al Clark: So, when you think about what's going on in China, it's probably starting to stabilise at the margin. But the issue that everyone's confronting right now is that it's spreading globally. So, we're seeing it spread to 65 countries, I think, at the last count with, unfortunately, about 3,000 deaths.
So, in an environment like this, I think people try and find historical precedents to lean on to help them understand what's going on. People tended to straightaway go to SARS as a useful precedent. That turned out probably not to be a great precedent. SARS was quite contained. The disease itself didn't spread quite easily. People have looked at the swine flu from 2009. I've even seen people go back and look at the Spanish flu of 1918 -- which, again, very different disease. I think the reality is it's quite hard to know exactly how this will play out. What we do know at this point in time is that it's a highly communicable disease with a fairly low mortality rate.
Natalie Comino: And what are the issues as you see them?
Al Clark: I think the key issue at the moment is how countries are going to react as it comes into their shores or crosses their borders. China was quite militaristic in the way they treated it, and I think at the time it was seen as quite extreme. In hindsight, that probably seems like the right way to approach something you don't understand.
The problem with that type of response is its impact on growth, and we're seeing that now. On the weekend, the February Manufacturing PMI, so the index to show how manufacturing's going in China, was really low. It came out for something like 35.7, which is even lower than November 2008. It's the worst, the slowest that reading has been out of China since the crisis -- or actually, I think, in recorded history.
The impact on growth from being so militaristic and shutting things down was quite profound. What happens now is other countries step back and think, "Right, well, what do we do? Do we follow that type of route or do we have our own way of assessing it?"
Natalie Comino: Does it affect how we invest?
Al Clark: Fortunately, it doesn't, for us. We manage the diversified portfolios using the Investment Futures Framework, and that naturally lends itself to accommodating new risks. We tend to think about all the possible range of outcomes and then think about, "Okay, what's that distribution of outcomes? How does that impact our portfolios?"
Something like a pandemic -- we actually had a pandemic scenario. We then look at that and think, "Okay, have we got the right parameters around that as this evolves?" And then understand how it's then impacting the overall holdings in our portfolios.
Natalie Comino: So, what does it mean for our portfolios, then?
Al Clark: We came into this quarter fairly defensively positioned anyway. I think we were concerned about the valuations across a range of asset classes, and so we were quite defensively positioned.
In the Inflation Plus series, we've got an overweight to gold as a real rate hedge. We've got an overweight to foreign currencies, particularly the US dollar and the yen. They do well when growth does badly, usually. And we've got a large overweight to volatility through a sort of tail-risk hedge.
All those defensive parts of the portfolio have been doing really well in the last few weeks or the last month. Now it's a matter of, "When do we start to change that?"
We've already changed the gold position. We took profit in that gold position last week, but maintained upside exposure through calls. And we're looking at the other positions just to make sure that, as the market gives us the opportunities to adjust those, then we'll make the decisions as those events transpire. That's in Inflation Plus.
In Horizon, Horizon was already underweight, slightly, in Australian equities. Horizon was overweight foreign currency exposure. And then the Horizon and the Index Plus series through their investments in Inflation Plus inherit all those defensive characteristics.
Overall, the portfolios were quite well positioned... It's always hard in an environment like this to feel like you're well positioned, but they were defensively positioned, and we've been making changes at the margin as the opportunity presents.
Natalie Comino: So taking some profits where they were available. So what happens next?
Al Clark: As I said, there's a broad range of potential outcomes from this depending on how countries react. The good thing is, in our process, we don't need to be epidemiologists or specialists in viruses, etc. We just need to think about that potential range of outcomes, and then lay that over our distribution of returns and say, "Is risk-reward trade-off sensible?
For us, what happens next is not necessarily the important thing. For us, it's the fact that we've already been able to embed in our investment process this type of risk. By that, we tend to make the future a little bit irrelevant.
Natalie Comino: Some of our investors are concerned at this time. You've been investing in the markets for probably decades now, Al. What would you say to them?
Al Clark: If they've been invested for a long time, then they've been through the benefits of the last 10 years really. They've participated in a significant rally in market. This type of correction is not really outside the realms of possibility at all. I would suggest probably just to be patient. Fortunately, that tends to be the way most people treat their investments.
We were defensively positioned, particularly because things looked expensive. As they become cheaper, that's actually a good thing. We'll look for opportunities to improve the overall risk-return profile of the funds, take those opportunities as they present themselves, and hopefully be able to give investors a nice way of navigating through these types of events.
Natalie Comino: Excellent. Thank you very much, Al.
Al Clark: No worries.
Natalie Comino: Thank you for your time and your insights.
Al Clark: Thanks, Nat.
Natalie Comino: And thank you for joining us.