Episode 2: Craig Maddock and Ian Taylor on Q1 2020: Reviewing market and MD Portfolio performance amid the COVID-19 pandemic

What looked like a pretty promising start to the year, took an unfortunate turn. What happened in the first quarter of 2020?

Ian [0:54] Obviously, the backdrop has changed dramatically. You know, the economy being part of that, but obviously just across the world with the health crisis that we're currently facing. And certainly, that wasn't something that was really with us at the beginning of the quarter. So, as things changed, obviously, the markets have reflected that and so has their outlook.

If we look over the last quarter, stock markets certainly towards the end of February started to sell off and sell off in a dramatic fashion – so some of the fastest declines in stock markets that we've seen historically. And at one point, you know, the global market was down over 30%.

Now, there has been some positive signs since the end of the quarter, not just with respect to the health crisis and positive developments in that sense, but also some stability in global bond and financial markets. But overall, for the quarter, stocks are down in and around 20%.

Helping to offset some of that risk, was the stability of bond markets and in particular, treasury markets. So, given the extent of the economic disruption currently due to the health crisis, bond markets were a bit of a tale of two halves. The treasury market did extremely well and anything that's considered more of a safe asset, but certainly more corporate bonds sold off. So overall, a balanced portfolio is down somewhere in the range of 10% over the quarter. But that, you know, obviously reflects some of the relief rally we've seen here, but towards the end of the quarter.

Now prior to the outbreak, you know, are were really seeing an environment where we were expecting some of the weakest growth since the financial crisis. However, we were expecting to see improvements throughout the year, and that was expected to play out through the stock market. Understanding that, you know, we were towards the later end of the cycle as opposed to the beginning of the cycle. With the Coronavirus or COVID-19 virus spreading globally, you know, that marked a significant change in the prospects for the global economy. Certainly, as policymakers reacted first on the health front to shut down the economy. But then, you know, on the monetary and fiscal side to provide substantial stimulus to try and get the global economy through this period. And so really, this is the key balance that we're facing, which is the short-term negative impact for sure – it's significant – it’s going to have a meaningful impact. And, you know, there may still be some negativity to be priced into markets from here. But then offsetting that is the longer term prospect, which will be stabilized at the back end of this by the awe-inspiring policy decisions that were made both from central bankers but also politicians as they co-ordinate on extensive packages to try to support the financial system. But also, just, you know, Main Street, the general economy. Those packages continue to roll out and there's still prospect for them to grow, even though, you know, they're already, announced measures are above 10% of global economic output annually.

So, the key question is, you know, where does the economy go from here? And what does it mean for financial markets? And as I mentioned, you know, it's really a health policy decision at this point. We know that needs to be – we need to get that right. And so what that means from an economic perspective, based on the information that's being shared now, is that this is going to be a very gradual reopening of the economy. And that's going to have profound implications for companies, their earnings prospects, depending on which sectors they are in. Certainly, how consumers react to this, and in particular, those who've been under some hardship, even though there is a lot of fiscal stimulus which, you know, ultimately will help support them through this crisis, it really is just to support them. It doesn't necessarily mean that things are going to go back to the way they were and that those jobs will still be there as companies try to assess what the future looks like.

So, although a number of companies are going to survive due to the aid that's been provided and lots of folks will go back to work, it's likely going to be gradual, it's likely going to be slower from a recovery standpoint. And then there's going to be the uncertainty of the health crisis and whether or not it will be contained and how long it's going to be with us. And so as a result, and Craig will speak to this a bit, we are still taking a bit more of a defensive stance. You know, there has been a relief rally here in the markets over the last few weeks. But really, the sustainability around that goes back to what's most likely to happen from an economic perspective. And our expectation is that it's going to be a gradual recovery and that there are still risks. Longer term, there's still the same opportunities that exist and actually, new opportunities will be created. But in the short term, there's still enough uncertainty that it warrants a more defensive stance as we look out the next six months.

MD has made a number of portfolio adjustments based on the latest information as it became available – going from cautiously optimistic and slightly overweight equities to a bit more cautious and underweight. Where do we stand today and where are we headed?

Craig [4:45] We’re similarly position to where we were the last call, but maybe just to reiterate, as Ian mentioned at the beginning of the year, we were positioned for a world of low global growth. So, you know, mid-late cycle, the time we were overweight equities, we were generally constructive on risk assets – that would show up in our currency positions, in our relative equity positions, bond positions. So, everything looked reasonable to expect that on a cyclical basis we should see the portfolio positions work out relatively well.

As you've noted, things unraveled very quickly, which meant that we needed to reposition portfolios as quickly as possible. We did move from our overweight equity position to an underweight equity position and increased the level of defensiveness across portfolios. So, sort of looking at about a 5% cash level in portfolios now relative to equities. So underweight equities, overweight cash or to fixed income to some degree.

We're going to continue to revisit that position as more information comes available, so Ian talked about the significant amount of stimulus, so whether that being fiscal and monetary support coming through to the economy. That's definitely caused a slight recovery here. And we're constantly reassessing whether or not we need to modify our positions.

So, we are not quite as defensive as we were at the extreme, but we still remain defensive in most parts of our portfolio with the expectation that we'll continue to see further negative information come out to the economy, which will get repriced into assets.

Short answer is we've got more cash in portfolios. Within our fixed income funds were relatively conservatively positioned compared to normal, so less credit exposure. And then within some of our equity funds, we've got a more defensive posture, whether that's through elevated cash levels, so a bit more cash than we would normally hold within an equity fund as well as some more defensive sector positioning.

At the end of last year, we really focused in on things like US-China trade, the execution of Brexit, the outcome of the U.S. elections. Are these still things that we're watching and assessing?

Ian [6:58] Well yes absolutely, Alex. So as much as the world has changed due to the spread of the COVID-19 virus and the real shutdown of much of the global economy, these issues remain prominent. And actually, it's certainly the events that we're seeing here are starting to have an influence on those particular topics.

That will be key as we enter into the recovery stage of this as to what that recovery looks like. So, if you look at something like the U.S. elections at this point, because things have changed so dramatically and there's so much uncertainty around what the pace of this recovery will be, how effective it will be, that's going to influence who gets elected as U.S. President. You know, there are materially different policy implications from that.

I would say that's not really the key focus of markets right now. But, as the initial fear here of the economic contraction and obviously the health crisis that we're facing starts to abate, those issues are going to become really in focus here and certainly into the third quarter and fourth quarter of this year.

So, as we take a look at that, it's really around does it have an impact on the extent of the recovery in the short term and how that plays out? Not really – that's mostly going to be influenced by health policy, although it will have an influence of the desire of politicians at this point. But more from a longer term theme, thematic perspective, when we're talking about things like U.S.-China trade, you know, supply chains are going to come in focus, just given the shutting down of borders and the implications of that. Perhaps where critical goods are manufactured will come into light. And that's all going to have a profound impact on those industries that are key to some of the production of those goods. So those are things that we're certainly looking at. And from a secular perspective, will cause us to change our positioning.

How have MD Funds and Portfolios performed?

Craig [8:43] Typical portfolio is down about 10% for the quarter. Higher equity weights obviously would have fared slightly worse and that clearly erased the gains that we would have seen in the past year. 2019 was a very strong year. We've pretty much erased all those gains. 3-year returns still remain positive for most portfolios so if you look at the longer term or if you are investing longer term, which you should be if you're an equity investor, even with this downturn, it's still positive, albeit not strongly positive. That doesn't sound so bad given the severity and velocity of the selloff we've just seen.

And as we were positioned for low growth at the beginning of the year, our portfolios did lag benchmark's in this rapid and unprecedented decline. I feel confident that we acted promptly to de-risk portfolios, but there really was no avoiding the pain, just given how quickly things did unwind as COVID-19, started to spread around the world.

Where I see the shimmering lights, our dividend mandates, which are position to be more stable, less cyclically geared generally, do look great for the quarter, as did our growth mandates. Now that probably sounds a little bit odd. You would normally expect growth not to fare as well in a downturn. However, our growth mandates are generally quality growth and quality growth could and should be expected to hold up reasonably well in a downturn. And they did. I think they fared a little bit better than we would have otherwise expected, which was certainly very pleasant to see.

In contrast, our value mandates took the brunt of the decline. It's hard to think of value sectors performing so poorly, in the past, in say the I.T. bubble, saw value actually outperform in the downturn. But given what's the shape of value these days being predominantly held in financials, financial companies certainly struggled in the beginning of this downturn, especially as we started to see, not so much a liquidity freeze, but markets we're starting to show signs before we saw a lot of stimulus come in from governments around the world.

Now, as we did note, we did act very quickly to make adjustments in the portfolios to the extent we see further deterioration in economic activity and ultimately that shows up in equity markets. We've repositioned portfolios accordingly and believe that we're now very defensively positioned to the extent that we see some more pain coming into markets.

In addition, the flight to safety that started the beginning of the correction, higher yielding corporate bonds as well as small cap companies in Canada, also fell further and faster than the larger, higher quality issues. Strategically, we do have both corporate bonds and small cap companies embedded in our strategies. Long term, those are great ways to add incremental value and manage from a risk adjusted return standpoint. Clearly, in the course of the type of downturn we've just seen, it's no surprise these strategies underperformed government bonds or high-quality larger cap issues. So that would be a negative for a few of our funds and ultimately contributing somewhat to the performance overall for portfolios.

Overall, the Multi-Asset Management Team at MD that manages the funds and the pools and our portfolios, you know, the team has been doing a tremendous job managing through this crisis. We've self-isolated ourselves since mid-March and have had regular contact with the team to talk about all the different pieces of information that are coming in very rapidly. And the quality of the people and the ability for us to digest the information and make adjustments at real time has really been good to see. So, I'm very pleased with the current position of our portfolios, with the actions and activities we've taken throughout this, and do feel that we are very well positioned for the recovery when it does come.

How have our fixed income funds performed? And how have they impacted the overall performance of our portfolios?

Craig [12:26] Bonds did their job in the current environment. So, stocks were down, bonds were up. And that's good because that's exactly how it's supposed to work. The reason typically we hold bonds in a portfolio is to balance off the ability to hold equity risk. We've got the right balance between seeking long term returns but being defensive enough when it's needed. And it was definitely needed in the quarter.

At the same time, yields are currently very low. They're even lower now than they were at the start of the quarter. So that does introduce a new challenge for the future. As we look out going forward, bonds will not pay as much as they used to, unless we invest in much higher risk issues. We're not likely to extend into too much higher risk. And that ultimately means the ability for bonds to continue to protect in a further downturn is mitigated at this stage.

So, they did their job this time. Their ability to do their job in a further decline with interest rates as low as they are currently, will be a bit of a challenge going forward.

Any closing remarks?

Ian [13:35] I think the important thing to stress right now is that it's a rapidly changing environment, as we all know. But certainly, from a financial market perspective, we're constantly assessing the new information. We have the ability to react and be proactive about this as well. And I believe we have a really solid partners from an asset management perspective, and the information we're getting from them is going to help us through this, as it has in previous events, throughout MD's history.

So certainly, as the facts change, we're able to assess that and make changes. And that's what we're going continue to do. So, I look forward to continuing to communicate that and guide ourselves through this particular environment and know that over the long run that this actually creates opportunities as much as it does negative returns over the very short term.

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