By Grant Mizens, Assistant Portfolio Manager, MLC
Financial markets, which had until now adopted a ‘wait and see’ attitude to the coronavirus pandemic, seem to have changed course.
On Monday, global shares had their worst day in two years and the Australian share market has in recent days seen its biggest sell-off since the depth of the US-China trade wars last August.
There appears to be a realisation that economic dislocations stemming from the coronavirus may be more significant than markets previously assumed.
While more Chinese provinces have downgraded their emergency response levels on reports infections have plateaued in the country, the virus is spreading to more countries with Iran, Italy and South Korea now among key sources of worry.
The vast majority — 90% of the new infections in South Korea, were in Daegu (population 2.5 million), the country’s fourth-largest city and the epicentre of the country’s outbreak, and the neighbouring province of North Gyeongsang.1
Stories out of China of people told to stay at home and not return to work; factory shut downs freezing global supply chains for everything from mobile phones to autos and pharmaceuticals; and dramatically lower consumer spending is causing investors to re-exam previous assumptions of a limited global economic impact.
Also under question are expectations of a post-Covid-19 economic bounce. The 2003 SARS parallels investors are looking back to as a guide may be inadequate, emphasising our view that the past can be a poor steer to the future, especially when the data set is limited.
It seems a stretch to assume Covid-19 will play out like SARS simply because both originated in China!
The Investment Futures Framework captures pandemics
Generally, investment professionals think about what is likely to happen, as distinct from what can happen.
By contrast, our Investment Futures Framework actively steers us away from this kind of comfort zone thinking towards understanding the many things that could happen (Chart 1) and then identify the most appropriate trade-off between risk and return for each of the portfolios we manage for clients.
Chart 1: Our Investment Futures Framework considers many possible futures, including a global pandemic (scenario 25)
Source: MLC Asset Management Services Limited
Rather than imagining one or even several sets of outcomes and their associated investment returns, the Investment Futures Framework recognises the possibility of a vast number of scenarios with a great breadth of return possibilities. This includes highly likely scenarios as well as ‘long shots’ like pandemics, such as the current coronavirus outbreak.
The coronavirus and the way it is disrupting societies, economies and markets demonstrates the Investment Futures Framework’s practicality and elasticity. Having pandemics as a possibility, even if remote, means that we’re not taken by total surprise when low probability events occur.
We’re not caught scrambling to analyse on the run. Perhaps the worst time to begin thinking about a low probability event is when it’s already underway.
For some time, we’ve been emphasising risk control in our MLC Wholesale Inflation Plus portfolios. In our MLC Wholesale Horizon and MLC Wholesale Index Plus portfolios, the overweight to foreign currency has helped to cushion these portfolios during recent market moves.
Likewise, options-based strategies in our Inflation Plus portfolios2 have helped the portfolios to mitigate the weakness in a number of share markets. Our gold futures position in these portfolios have also contributed positively to returns as investors flee risk for traditional safe-haven assets, including precious metals.
Events and markets are moving fast. We are continuing to be vigilant on behalf of our clients.