Since our last update earlier this month, markets around the world have reacted sharply to the coronavirus pandemic, moving to price in a severe long term deterioration in economic activity.
While the short term impacts on many countries around the world as they effectively shut down parts of their economies are likely to be significant, it is not clear as yet what the medium to longer term impacts might be. It is clear to us though that some businesses will be impacted more than others.
Historically, in the absence of clarity as to when the worst of a certain environment (e.g. the global financial crisis) is likely to pass, markets have typically gravitated towards factoring in a worst case scenario. Our assessment is that markets are a fair way down this path.
A big part of what the impact on the global economy will ultimately look like will be a function of how governments and central banks around the world respond to the situation.
Central banks have been prompt to act, with numerous central banks such as the US Federal Reserve (the Fed), the Bank of England (BoE), the Bank of Canada and of course the Reserve Bank of Australia (RBA) reducing interest rates. In addition, the RBA, the Fed, the European Central Bank and the Bank of Japan to name a few have all either introduced or increased quantitative easing (QE) programs. The RBA, for example, has also made it clear that it will do whatever is necessary to support the financial system (QE effectively involves central banks injecting considerable liquidity into the financial system to help it continue to function normally).
Governments around the world are also in the process of injecting billions and billions of dollars into both the public and private sectors to support jobs and spending. Significant restrictions have been placed on travel, and people are being encouraged not to gather in large crowds and to keep social contact to a minimum. In other words, significant steps are being taken to control the spread of the virus.
In terms of the impact on credit markets, similar to other asset classes, corporate bond markets have been impacted meaningfully by this dynamic, as distressed investors and those requiring immediate liquidity become forced sellers. This has had a material impact on the prices of corporate bonds globally – right across the credit rating spectrum – and as would be expected it is having a negative impact on the Fund’s daily unit price.
Over its almost 20 year history, we have always taken great pride in the fact that through the cycle, we have achieved the performance objective of the PM Capital Enhanced Yield Fund with a relatively low degree of volatility – despite having to navigate the global financial crisis in 2008/09, the European debt crisis in 2011/12, the China growth scare in 2015/16 and Brexit concerns in 2018/19. Keeping volatility low through the cycle is and always will be one of our core objectives in managing the Fund.
Amid the current environment, we expect the unit price of the Fund will be considerably more volatile than normal, and thus we expect monthly returns to vary a lot more than usual – in both directions. It is worth noting that over the almost two decades since we started the Fund, the average time to recovery of a negative performance month has been less than two months, and the Fund has generated positive performance in almost 90% of all months since inception.
Prior to the turbulence being experienced in markets this month, the Fund had a cash position of approximately 50% - which we had been patiently holding, waiting for an environment where the risk/ reward equation was far more in favour of the investor. Our patience has now been rewarded.
We have already begun investing the Fund’s substantial cash balance, making investments in corporate bonds at valuations that we think we may not likely see again for a long time. These investments are in companies that we believe will weather the current environment well, and thrive over the longer term, potentially adding meaningfully to fund performance over time.
The Fund has no direct exposure to airlines and other travel service providers, who have been hit extremely hard in the current environment.
The current market environment in some ways is unprecedented. Liquidation of assets by forced sellers (rather than willing sellers) has been to a great degree indiscriminate. With our substantial cash balance noted above, we are in the very fortunate position of being a buyer - not a seller. Nonetheless, parts of our existing portfolio have obviously been devalued. We are confident that once markets normalise, these mark to market devaluations will be recouped, especially as the time to maturity of the bonds get shorter and shorter.
In terms of a true turning point for markets, having seen significant monetary and fiscal stimulus from central banks and governments around the world now, the last port of call is likely to be when the number instances of the virus around the world starts to fall notably - as this will be when fear starts to subside. Conversely, the best time to invest capital is generally where fear and panic is at its greatest. We suspect that we are pretty close to that point now - so we have begun investing the Fund’s capital – slowly and methodically.
As always, our highest priority is to preserve investor capital. As most if not all of you are aware, PM Capital itself has a material investment in the Enhanced Yield Fund, so the decisions that we make for our valued clients are also decisions that we are making for our own capital. With our large cash balance we are excited by the opportunities being presented by markets currently and firmly believe that we are in a position to successfully deliver on the Fund’s long term performance objectives.
We will continue our regular communication with investors, via our regular monthly and quarterly reports, as well as updates like this one if there is additional information we feel necessary to communicate to investors.
In the meantime, we hope that you and your families stay healthy, and we look forward to sharing the investment journey with you in the years to come.
Global Yield Portfolio Manager
This note is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Enhanced Yield Fund (ARSN 099 581 558). It contains summary information only to provide an insight into how we make our investment decisions. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider a copy of the Product Disclosure Statement which is available from us, and seek their own financial advice prior to investing. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.