Core Portfolios and the coronavirus

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For intermediaries only

The coronavirus, as you know, has had a significant impact on financial markets, just as it has on all of our personal lives. The UK equity market experienced the sharpest falls during quarter one 2020 and endured its worst quarter since 1987. Even US equities, apparently resilient to all adverse forces for over 11 years, tumbled faster than ever before – and that includes the Great Depression of 1929.

Government bonds in developed markets, however, have been the stand out asset class, regarded as safe havens in troubled times as yields dropped to historic lows.

What does this all mean for our Core Portfolios?

The Core Portfolios cater for a broad range of risk appetites with seven funds, ranging from Conservative, the least risky, to Adventurous, the most risky. Their main objective is to deliver the best possible performance for the amount of risk taken, using mainly passive investments to reduce costs.

As can be seen below, the portfolios have responded in line with their given risk levels. Over the first quarter of the year, investors who chose higher risk levels suffered losses consistent with the higher proportions of risk assets in their portfolios. Whereas investors who chose more defensive portfolios, were protected from the larger capital losses. Those in the Conservative fund even received a small gain.

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However for those who have suffered larger losses because they have taken on more risk, it’s important to put it this context – since the funds were launched in 2012, returns across the Core Portfolios funds have ranged from 5.0% to 8.7% a year.

To add further context, when compared to similar multi-asset fund ranges since the Core Portfolios inception in 2012, they also perform strongly.

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Asset allocation

So let’s dig a little deeper into the performance of the funds. As you’re aware, we work with Morningstar, award-winning investment specialists with extensive research capabilities, to create the optimal strategic asset mix for each fund in the range. This process focuses on how markets are valued relative to long-term future expectations. This gives us long-term conviction in our allocations. The asset allocation for each fund at 30 April 2020 can be seen below.

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Overall the portfolios have lower equity and bond exposure than we’d expect over the long-term. For equities, we favour UK over US. This is not intuitive in light of recent performance, however we focus on looking forward and we see better value in UK equities where valuations are less stretched versus our view of future earnings potential in the US.

For bonds, we have a preference for investment grade credit as government bond yields decrease further. Cash weightings in the portfolios were at elevated levels going into the first quarter of the year, reflecting our over-arching cautious stance in light of richly valued asset prices across both equity and fixed income, and we retain this view.

The outlook

The economic impact of the coronavirus is interesting because, unlike many previous equity sell offs, the cause is not financial. The cause is a virus. And it appears that virus experts have many different views about the coronavirus in terms of how long it might last, how widespread it is and what the best policies to implement to tackle it are. This means there’s a lot of uncertainty.

To cut through this and help us understand the impact on investments, we’re trying to answer two questions: how long might the effects last, and how deep will the effects be from an economic angle?Arrow_graphic-01.jpg

The two bookend scenarios are i) a deep recession followed by a sharp recovery, and ii) the worst case scenario, a depression where this slowdown carries on for many years. Our research is ongoing but, given the actions by authorities and some indications from the likes of China and South Korea, it seems that some restrictions can be lifted without, so far at least, evidence of a second spike. As such, we’re starting to favour the recession scenario over a possible depression, but we’ll continue to challenge ourselves on this thinking.

This framework is important for our decision making because if we do move more towards the shorter, sharper recession scenario, then there’s a buying opportunity. But if we start to conclude towards the depression like scenario, then we’d need to relook at valuations and ensure they’re sufficiently stressed and our more defensive portfolios are appropriately set up.

And we mustn’t forget, there are other issues out there which can impact returns. The US election being the most notable currently. We’ll continue to assess the impact of this and other risks alongside the coronavirus.

In summary

The short-term impact on markets has been significant. The Core Portfolios have been supported to some extent by the diversification inherent in the funds, and prudent asset allocations for those with lower risk appetites. While the Conservative fund returned a small gain, the other funds in the range did suffer near-term falls. Despite this long-term returns remain positive across the board.

Opportunities may exist but much is still unclear and downside risk remains. It’s important therefore that investors are clear on their risk appetite. The Core Portfolios aim to achieve a balance between risk and reward that is in line with investors’ long-term expectations. Through this period of market volatility, the portfolios have responded in line with their risk levels and have performed favourably compared to peers since inception.

Through expert asset allocation and rigorous governance, we’ll continue to position the portfolios to meet their long-term objectives.

 

If you have any questions or would like to find out more about our response to the coronavirus outbreak, please speak to your usual Aegon contact or go to our Advice Makes Sense web pages.

And to hear more about Richard’s views on asset class convictions in the current climate, please view our recent webinar

This market update note is based on our understanding of the current and historical position of the markets and shouldn’t be interpreted as recommendations or advice. Past performance is no guide to future performance and the value of investments can go down as well as up. Investors may get back less than they invest.