March 27, 2020
No corner of the capital markets has been spared fallout from COVID-19. Investors are reacting in characteristic fashion by flocking to businesses with cash and low levels of debt, and liquidity is hard to find. We are in a bear market and surely an economic recession. I wanted to provide a few thoughts and perspectives on the current environment as well as comment on portfolio positioning.
After such a long bull market, we had been expecting a pullback at some point. Trees cannot grow to the sky. However, the circumstances that lead to corrections or bear markets are often very difficult to call precisely – yet we now know it is a bona fide pandemic and it has brought the global economy to a grinding halt. That has led to a sharp drawdown.
I am reminded of our investment teams' depth of experience gained by managing money through many difficult periods. These include the crash of ’87, the near depression in Canada in the early 90s, the 1997 Asian financial crisis and failure of Long-Term Capital Management in 1998, the dot-com bubble, and of course the financial crisis of 2008-09. This valuable experience is being applied in our analysis today.
Generally speaking, positioning of our portfolios coming into the weakness was defensive. We had used strength in equities and corporate bonds over the past few years to reduce investment positions in these asset classes. The equities in client portfolios are globally oriented, high quality, broadly diversified, and focused on delivering returns on invested capital. They have held up relatively well. Additionally, we have been building positions in private market assets, such as infrastructure, commercial real estate and private loans, which are long-term in nature. All of these strategies have helped client portfolios weather the storm.
The last few weeks have been exceptionally busy with constant internal meetings among our investment teams tracking the fast-evolving situation – our portfolio managers are revisiting their analysis of every security held in clients' portfolios. They are assessing the prospects for each business: the sustainability of expected income, be it a stock dividend, a bond or loan income payment, rental income from property, or payments from infrastructure agreements. Each asset is also being evaluated in light of what has transpired to determine its prospects for performing in the months to come and during the inevitable recovery.
It is during times like these the value of meaningful diversification comes to the fore. A mix of public equities and fixed income and also, for those who elected to include them, private market assets. Greater latitude in allocating clients' capital allows us to capture a wider set of opportunities and ways to mitigate risk. We are seeing this play out today and are convinced it remains the right approach for tomorrow.
Here is a look at each of the major asset classes:
- Bonds – High quality government bonds have held up well. Their stability is welcome; however, looking ahead they will offer investors little return. Corporate bonds are falling in price, exacerbated by a lack of buyers which is typical of periods such as this. Not unlike our experience during the great financial crisis, these times provide bargains, offering good returns. We expect to add to positions where the opportunities are attractive.
- Equities – Virtually all equities are now priced lower. Nevertheless, our client portfolios have held up relatively well as we have focused on companies with low levels of debt, robust cash flows, and defendable market positions. We are confident that clients will be rewarded for staying invested, the alternative being far too difficult to time, i.e., moving out of stocks now and into cash and then back into stocks later on. The outlook for equities beyond the short term is attractive. We have been adding back to stocks during this period, and will continue to do so.
- Hedge Strategies – The last few years have been challenging for hedge strategies. Returns have been below expectations and have not kept pace with the returns of stocks or bonds. Going forward, strategies designed to deliver returns regardless of the direction of markets will be attractive and important to clients, especially as an alternative to bonds.
- Real Estate – We entered this period with low debt and high quality, long-term properties. The portfolio is well diversified across Canada with low exposure to Alberta office and retail, two areas with the most uncertainty. Near-term impacts, predominantly from retail rent deferral/abatement related to COVID-19 and to a lesser extent from the effect on office and distribution facilities, do exist. However, the medium-term outlook remains attractive for the type of well-located, high quality assets in the portfolio.
- Infrastructure – The contractual nature of the majority of our operating assets and the high quality of offtakers have provided a strong degree of protection from the current COVID-19 pressures. We do not currently anticipate material impacts on our contracted renewable power assets or on our operational public-private partnership (P3) projects, which are underpinned by long-term, availability-based concession agreements. These types of contracted assets represent the bulk of our portfolio. Our Chilean Solar and VIP Rail business will likely experience some downward pressure on pricing and volumes as a result of a slowdown in economic activity; however, we largely expect that this will be temporary. All still offer excellent long-term prospects and continue to look very attractive.
- Private Loans – The past few years have been characterized by easy money on favourable terms for businesses. This backdrop has made it difficult for us to deploy capital - favouring discipline over capital deployment has meant we have lent less. Going forward a more balanced market will result. The businesses we have lent to have strong sponsors and undrawn reserves to see them through short-term difficulties. We have a talented and experienced private loans team who are active partners alongside borrowers. This is especially valuable in achieving long-term results for the businesses and investors.
It is worth remembering that we are invested alongside our clients. Connor, Clark & Lunn Financial Group Ltd. holds a significant position in every one of our private market ventures. Our interests and clients’ interests are clearly aligned.
Every day, equity prices reflect not only what we experience in our daily lives, on our TVs or computer screens, but also the collective view of investors about what is to come. It is impossible to predict when stock markets will start their recovery. We know from experience the bottom will only be evident in retrospect. But at some point, regardless of the flow of bad news, asset prices will stop falling and move higher, possibly sharply.
We believe we are well positioned at Connor, Clark & Lunn Private Capital Ltd. to handle the stresses and strains of this challenging time on clients' behalf. Significant planning has allowed us to quickly transition our global operation to work from home, focusing on the health and well-being of our employees and clients while maintaining our obligation to manage clients' wealth. Our firm is strong and well-capitalized, with broad and deep investment, operational and client teams.
Clients can take comfort in knowing that we are working hard to manage their wealth so they can focus on the well-being of their families and communities.
From the desk of Jeff Guise, Managing Director, Chief Investment Officer, CC&L Private Capital.