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I hope this message finds you and those close to you in good health as we all navigate the fallout that happens when a health crisis spills over and triggers an economic crisis. As the daily headlines continue to mirror the historic magnitude of the situation, I wanted to take a moment to highlight how we at Russell Investments have mobilized around our highest priority—our clients.
While there’s no playbook for COVID-19, we applied important learnings from the 2008 Global Financial Crisis (GFC) to this new crisis. A War Room was immediately instituted with a cross-functional team of leaders from Investments, Operations, Compliance and Legal meeting on a daily basis. In the most volatile times, this team focused on the operational issues to ensure our funds met all margin calls and had appropriate liquidity to support rebalancing. For instance, we raised the liquidity reserve levels in bond portfolios, maintaining exposure through cash-backed derivatives rather than participating in physical securities.
Finding active returns was challenging in the first quarter, with indiscriminate selling across both fixed income and equity markets impacting our funds. However, as markets begin to normalize, we have seen encouraging green shoots of performance.
Similar to the GFC, the recent market volatility opened up significant dislocations in the fixed income markets. Our strong conviction in credit has served our clients well over the last ten years or so. However, that performance understandably reverses some when we hit pockets like this.
On a positive note, we have seen credit spreads tighten significantly over the last few weeks, and we are actively looking to take advantage of the opportunities.
Within equities, our value bias continued to underperform during the first quarter as the market sold off more in value sectors than in growth sectors of the markets. Our research teams and portfolio managers revisited our strategic belief in value and find ourselves even more convinced that our clients will see significant returns from this active position. We expect value to come back strongly as investors once again begin to discriminate between firms based on valuation.
The way forward
The current crisis comes with new complexity as economic policy decisions made by governments need to be balanced with health concerns. That said, the policy intervention around the globe is unprecedented. Global COVID actions and market movements led world governments to flood the economy with liquidity and financial programs to help people and businesses. Global government actions have also been historic in both timeliness and magnitude, even compared to 2008, when Mario Draghi promised to do “whatever it takes.” As of April 22, the total global fiscal stimulus was already more than $8 trillion, representing roughly 9.3% of annual global GDP (gross domestic product), with the U.S. representing $2.3 trillion of that amount.1 In addition to this critical fiscal stimulus, both the Federal Reserve and the European Central Bank have categorically stated that there are “no limits” to the support they will offer to the global economy.
In our opinion, current volatility has resulted in a stock picker’s paradise. Active managers need more than skill to win. They also need an opportunity set to demonstrate their prowess. Technically, they need high levels of cross-sectional volatility, a condition captured nicely by looking at the level of analyst dispersion around stock price targets which is at historic highs. This uncertainty creates an opportunity for the talented stock picker to meaningfully outperform. The recent large sell-off saw indiscriminate selling at an individual stock level, limiting opportunity for active managers.
Active managers also want breadth, and the very narrow market leadership of the largest ten stocks created significant headwinds for the fundamentally focused. With our entry into the recession phase of the economic cycle comes the good news that the next phase will be recovery. We believe this may start in the second half of 2020, and those parts of the market that have been very out of favor for a long time—value and small cap—tend to significantly outperform in this phase of the economic cycle. I am extremely confident that in the next few years we will see active management come to the fore.
My advice to clients
We believe that patient, strategic investing will be rewarded. In the meantime, it is essential to get the big stuff right. In other words, executing on your strategic asset allocation will have a significant impact on your long-term goals. This situation will be with us for a while, so time is on your side when looking for opportunities. At Russell Investments, we are keeping an eye on the short-term markets, but are patiently bullish and believe that keeping a focus out two or three years will bear more fruit.
As always, reach out if you have any questions or would like to discuss the content in this message. We are deeply committed to providing financial security to our clients, and we remain vigilant on your behalf.
1 Source: Bloomberg (https://www.bloomberg.com/news/articles/2020-04-23/when-8-trillion-in-global-fiscal-stimulus-still-isn-t-enough) and The World Bank.
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