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Staying true to the long-term on 'The long and winding road'

7 May 2020 by  Ed Tomlinson

The Beatles song 'Long and winding road' is about overcoming adversity and staying on course to reach your goal. While the song is vintage, the idea it pushes is very relevant for members worried about KiwiSaver returns today – there will be short-term set-backs during your financial journey, but despite these hurdles it is important to remain focussed on your long-term investment goals.

The forced shut-down of the global economy due to COVID-19 is undoubtedly a very large set-back and it is incredible how quickly things have changed in a short space of time. World share markets were at all-time highs in mid-February, many dropping 30% by mid-March, and then some markets recovered more than half of the loss by the end of April.

This result, while very disappointing, is in line with the movement of major markets such as US shares.  The New Zealand share market is well ahead of the Australian market, which has recovered less than a third of its losses.

Source: FactSet Research Systems Inc.

While share markets can be poor at identifying the exact timing of economic turning points, the message they are providing right now seems clear and appears to be consistent with government and health viewpoints. We are now mid-way through one of the largest economic declines in modern history. The markets seem to be indicating that the worst-case scenarios have been contained, and as we gradually make our way out of lockdown a fast and full economic recovery seems unlikely, meaning a new global ‘normal’ with lower earnings should be expected in the medium term.

New Zealand’s lock-down was notable for its severity and intent to eliminate COVID-19, rather than the less aggressive ‘flatten the curve’ goal pursued in other countries. The New Zealand approach seems poised to achieve its health goal, but the true economic cost is likely high with the Treasury reporting forecasters’ consensus of a recession of close to 20% in Q2, and unemployment nearing 10% by the end of the year (reported on 1 May 2020).

Although we won’t know for a few months precisely how deep the recession has been, the aggressive and decisive government intervention globally has helped minimise the economic and social impact of the economic shut down. For example, the financial support includes:

  • The US government has approved more than US$6 trillion for asset purchases, loans and payments to lower income households.
  • The Reserve Bank of New Zealand aggressively cut the Official Cash Rate from 1% to a record low of 0.25%, providing support for the currency market and increased its newly launched bond purchasing programme to NZ$60bn.
  • The New Zealand government expanded its initial $12 billion COVID-19 response package to more than $50 billion in May.   

Source: MSD, as at 8th May 2020

In early May many governments began relaxing restrictions, encouraging adults back to work and children back to school. The great re-opening decision may prove premature for some countries from a health viewpoint but seems necessary from an economic viewpoint to restrain the already extensive economic damage. While the re-opening may allow the infection rates to creep up, no-one knows by how much, due to the unknown nature of the virus. The presence of this risk explains the drive towards infection tracing apps (in Australia for example) and vaccines, which are perhaps the only health-focussed alternatives to mitigate future lock-downs.

As positive sentiment returned in late March, share market levels have improved and the returns across April were amongst the strongest monthly results on record. Bond markets have also calmed, although their positive shift was more around the return of liquidity (the ability to buy or sell) rather than a change in value.

Importantly share market levels have not returned to their pre-crisis highs – the world has changed, economic uncertainty remains high and medium-term earnings for many companies uncertain, but very likely lower. Viability of certain industries and business models have also been challenged. These changes seem likely to bring forward trends already underway, such as the movement to online retailing. For certain sectors, such as air travel, we don’t know what the future holds. So, while we are optimistic that the economic recovery can start quickly and strongly, we are cautious about the current bullishness of share markets and we view the risk of another fall in returns as high.

Returns achieved for members

Returns have been difficult in the first quarter of 2020 due to the market volatility and economic uncertainly we are experiencing. Despite this set-back performance over the long term remains attractive and most of our funds have achieved higher than average returns over the long term.

Time in the market, not timing during volatile times

We understand you may be worried about the market losses and feel some anxiety about the future of your investment portfolio. When the short-term performance is negative, as it is now, we encourage members to keep focussed on their long-term goals.

The recovery from COVID-19 is likely to take some time. Recall the long and winding road; we expect the recovery to take some time and this highlights an extremely important point around attempting to “time the market”. Long-term investors who can look past market stresses have historically recovered their losses over the proceeding months and years. We believe this consideration is pertinent for members who are considering switching funds or withdrawing.

Portfolio update

Our managers invest for the long-term and remained broadly invested with their existing investment strategies and biases across the quarter. The changes that were made varied by manager. Milford, who can be an aggressive asset allocator, benefitted early in the crisis from its high cash allocation. ANZ held its position and benefitted from lower exposures to certain companies in the travel and retail sectors. Russell also made few tactical changes, but did enhance its strategic position in global shares by allocating more money to their managers Nissay (Japanese companies) and Oaktree (emerging market countries). Nikko took advantage of price increases in Auckland International Airport and Metlife Care to sell their positions, while its yield focussed approach within New Zealand bonds helped it recover quickly in April once the low in markets had passed.

Looking ahead

We think extreme caution should be applied to any view that the events in the coming weeks and months will be highly predictable and easy to navigate. The economic shutdown we are currently experiencing is unprecedented in both the level of economic disruption and speed it has ensued. There is also a level of uncertainty surrounding its re-opening.

The short-term investment problem may be false starts to the share market recovery, and the rally across April could be one of these. As we think future company earnings are very uncertain, this rally seems fragile at present.

Despite the rally, the losses of the first quarter of 2020 are yet to be fully recouped. This makes sense to us as the new economic normal is unlikely to be as strong as the previous version any time soon, and many of the business models that did well in 2019 must be re-engineered for the post COVID-19 environment. This means that while the Aon team are encouraged by the recent surge in markets, which indicates the extreme fear of mid-March has past, we anticipate further volatility along the long and winding road to recovery.

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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