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COVID-19 and its effect on the investment markets

18 Mar 2020 by  Ed Tomlinson

The transformation of the Coronavirus (COVID-19) into a global pandemic has sent a shockwave through global financial markets.

It is important to recognise that this current crisis is firstly a health crisis, which will have an impact on the overall economy and severe impact for sectors reliant on international travel such as tourism.  It is not a financial led crisis, and since the GFC in 2008, the global banking system has made many improvements and is better able to withstand shocks. Once the challenges posed by the virus pass it is possible for financial markets to return to their previous state. However there remains a good deal of uncertainty and the markets may not achieve previous levels.

Why have markets been volatile?

Investment markets work best when all information is understood and there has been time to digest the implications of news. Volatility results from new information that has an uncertain outcome, or information that flows quickly and unexpectedly. As there is little modern precedent for a fast spreading pandemic, investors have had difficulty in understanding the economic implications of COVID-19.

Adding to the health news flow are many announcements by central banks and governments of economic support, via fiscal and monetary stimulus, alongside restrictions in travel and social interaction (and new phrases such as “social distancing”). The volume of announcements has been a defining feature of the past three weeks.

How bad has the sell-off been?

The share market falls of the past month can be measured as amongst the worst on record, depending on which dates are assessed. This is because there have been large daily movements in share markets both up and down.

Source: FactSet

The cumulative total return of the above movements in the (US) S&P 500 Index was -29.4% (the Australian ASX 300 achieved -29.6% and NZX50 -21.5% over the same period) making the current crisis one of the worst in history.

Movements of such magnitude have happened before. For example, the below chart provided by AMP Capital shows that the current loss in the ASX in 2020 is the 7th large share market drop in the Australian share market’s history.

What has this meant for short-term investment returns?

Returns of almost all investment strategies with an allocation to growth assets (eg shares) are expected to be negative since the market peak on 20th February. Strategies having a higher allocation to listed shares have performed the poorest to now. However, notwithstanding the last month of losses, share strategies have tended to have the highest returns of all key asset classes by a large margin over the previous 10 years.

Members invested in the more diversified options, such as a “balanced” options have benefitted from exposure to many asset types including investments with positive returns, such as government bonds. Here diversification has done its job and reduced volatility and loss for those members.

By far the best returns over this short period were available in fixed interest focussed options whose returns were flat or positive. But this result should be considered in context of long-term returns - members invested in those investment options have missed out on the strong returns available across the previous 10 years and are likely to have achieved lower long-term returns overall.

The investment returns for both short and long-term periods of our funds are available on our website.

We recognise that the market movements and the news flow may be unsettling. If the lifecycle of other viruses proves to be a good guide, this pandemic might peak within several months, up to a year. This means the market volatility and further losses resulting from COVID-19 could also have a limited lifespan. With an improvement in sentiment and less ‘noise’, members can look forward to more stable returns than we have experienced over the past three weeks.

Members should make sure they are invested in a fund which is appropriate given their tolerance for risk. This could be particularly important for members who haven’t reviewed their fund for a while, or are near retirement. We recommend members seek independent financial advice that can help them understand their tolerance to risk. Our online risk profiler can also help members understand their attitude to risk and help them determine which fund might be right for them.

Should members change their investment strategy or withdraw their money?

Volatility is an integral part of investing and it should be expected from time to time. We suggest viewing the recent volatility and losses in the context of the long-term returns achieved as shown in the next chart and table.

Source: Factset

Since 2001 there have been five times where the NZX50 has fallen by more than 10% in a month. If an investor had decided to de-risk their portfolio (move to cash) after any of these losses, they would have missed out on the returns shown on the next chart.

All market data provided or inferred is sourced from FactSet. Other comments are Aon’s opinions or events widely reported in the press.

Need some advice?

If you are concerned about whether you are in the correct fund for your individual circumstances we recommend you complete our risk profiler to establish if you are in the correct fund and then seek the advice of a financial adviser if necessary.  A financial adviser will take all your personal circumstances into consideration when advising on your investment and retirement savings and which fund is appropriate for you.

Ed Tomlinson

Ed Tomlinson, CFA is an Investment Consultant and Head of Investments for the Pacific Region. He joined Aon’s UK asset management business in 2016 and was initially responsible for pension clients in the UK. In February 2019 he relocated to the Pacific to lead a team of investment consultants who advise clients in New Zealand, Australian and Papua New Guinea. Before joining Aon Ed worked for a leading European bank implementing fixed income strategies for insurance companies. He started his career in 1996 as a research analyst providing support to a leading Australian Listed Property Trust and multi-manager business. He is a CFA charterholder and was awarded a Graduate Diploma in Applied Investments by FINSIA.

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