As an absolute return fund manager who invests across asset classes, the last few weeks have been nothing short of fascinating. It’s definitely a period that we’re all going to remember in our careers.
If we go back to earlier in the month of March, we saw what can only be described as a dash for cash. Investors were selling anything that wasn’t nailed down. There were clearly concerns not only about the crisis itself but about redemptions coming from investors that caused a lot of forced selling in the market and continue to cause some forced selling in the market.
But it was really across all asset classes. It wasn’t just risky asset classes like equities or high-yield bonds but even U.S. treasuries, even gold. Asset classes that are traditionally considered safe havens were selling off just indiscriminately. The problem with that when you have all asset classes declining at the same time is that there are a lot of investment strategies out there that depend upon those asset classes being negatively correlated. Take for instance risk parity, a very popular strategy that has worked very well for a very long time. The idea is that you go long risky assets like equities and then you go long risk-free asset classes like U.S. treasuries. Over time, you’re hoping you can make money in both asset classes. But in the short term they hedge each other very well and you end up with this very low volatility, positive return stream. As we learned this month, that works great until it doesn’t.
Once those asset classes actually start declining together, it causes risk parity fund managers’ risk model to start sending a whole different signal. If those correlations are no longer negative, then in order to decrease the risk in the portfolio the only thing that manager can do is bring down his total exposure and sell both asset classes, both the risk-free and the risky assets. And so that’s what we saw happening. It’s not just risk parity, but we saw a lot of players in the market that were forced into deleveraging and decreasing their positions. That just causes a negative feedback loop where selling begets even more selling. When that happens the only way to end the downward spiral is through the intervention of the Fed.
So when there’s a generalized panic in the market like we saw what has to happen often is that the Fed needs to intervene, and the Fed intervened and continues to intervene. And that has definitely helped. It has definitely helped in the asset classes where the Fed is directly intervening such as the treasury market, mortgage markets. And even now the Fed is planning to intervene in the investment grade corporate bond markets, so we’ve seen those markets get much healthier as well. But it creates this bifurcation because there are still other assets where the Fed so far has shown no interest in intervening. Think about the sub-investment grade bond markets such as high yield, leveraged loans. So far there’s no interest in helping those companies, and as a result that asset class definitely feels like it’s been a little bit abandoned.
The interesting part of this is that there’s a political side to this as well. So the fiscal package that was just passed by Congress contains a provision where by congress will appoint a committee that will oversee the asset purchases by the Fed. It will be a political committee, a mixture of Democrats and Republicans, so then that raises some interesting questions. Even though thus far the government has not shown an inclination to intervene in the high-yield market, what if there were a high-yield issuer that was a very large employer of low-wage workers, would they be willing to intervene then? It creates an interesting situation for us an investors, where often times now we’re having to make decisions that are as much about the politics as they are about the economics of the situation.
Moving onto equities, I would say that we’ve seen a similar phenomenon over the last few months where at the beginning of the month in March there was just indiscriminate selling, pretty much all stocks were going down as a lot of asset managers were forced sellers in the market. Over time, however, we’ve seen that start to change. Certainly, over the last week or so we’ve started to see healthier markets in the sense that it’s now starting to separate the winners from the losers. So safer equities, say something like utilities, have definitely been outperformers relative to the market. Strong, secular growth stocks, particularly some of the big tech names that have fortressed balance sheets, those have done very well.
Meanwhile on the flip side, equites that are directly impacted by this crisis have not faired as well. Think of airlines and hotels and cruise lines and things like that. The market is at least making a little bit more sense and is starting to divide into the winners and the losers. That’s good for us. That’s good for us as active managers because that’s, through our research, we think is what gives us our edge so our hope is that as we now go from this panic phase in the market to a market that starts separating out the winners and losers, both on an asset class level and on a company specific level, we think that it’s an exciting time for us as active management to outperform.