Future we hope for
There is one thing and one thing only, which worries every person on earth. That one thing is the future. Very simple when you consider it. – Anonymous
Traditionally, the assessment of investments and forecasting future valuations have been based on a simple fundamental – if you can get good information, you can lay out the future cash flows relatively easily and value the businesses for investment purposes. In radically unknown times, the unknowns far outstrip the knowns. This is where we currently are with COVID 19. We cannot simply project the future cash flows and claim this as an intelligent effort. Many sectors and companies are struggling to see a clear path forward.
Many people assume there is just one possible future which is like the present or the past. In reality, forecasting future is like peeling an onion, there are many layers to consider. The future is often not like the past or present. It is never one thing, but a range of possibilities. As investment professionals, it is part of our daily jobs to read and interpret significant amounts of financial information and news to navigate the ever-changing investment landscape. We have noted a common theme amongst some of the industry thought leaders, i.e. to assess the future investment opportunity set on basis of different scenarios and making decisions by assigning probabilities to these scenarios. We have simplified most of these themes into three groups:
Future we hope for – Vaccination and international travel – best case scenario, where firms will resume operations at pre-COVID levels.
Future we prepare for – Similar to current restrictions, whereby travel is restricted between states and social distancing severely impacts the economic environment. This constitutes the worst impact on firms, with severely diminished cash flows and low scope for growth.
Future we want to avoid – Another wave of COVID-infection and the return of the severe lockdowns. (Worst case scenario)
Ultimately, the global economy will critically rely on how the pandemic evolves; a successful COVID-19 vaccine to combat the virus is central to the economic outlook.
The global pandemic has changed the world forever, decades of industry change has been forced into just a few months. We believe it is the time to be cautious and selective – find favourable risk-return opportunities and think about the future as a range of possibilities instead of trying to predict a singular outcome.
The singular outcome mindset is driving a cohort of investors to place large sums of their wealth into speculative investments with a hope to make a quick fortune. These investors have been termed by the media as RobinHood investors. Many of these people appear to have no training or experience in trading. We all know how that story ends. It is blind money overly focused on making quick profits without a lot of thought on the major changes that will occur in the next 10, 20 or more years.
Toowoomba and Byron Bay are 200 km apart. If I follow a 100 km/h speed I can cover the distance in 2 hours. But if I speed up and drive at 200 km/h, I can cover the distance in only one hour. If I successfully pull this stunt and survive, am I right? Should you try it because it worked?
We are likely to see an uneven recovery. Some sectors of the economy will break, some will slowly improve, and others will hit the ball out of the park. Many large companies held within the index will not survive and new small companies will become part of the index. We acknowledge the unprecedented uncertainty and remain cautiously active and strategic while making investment decisions. Overall, the global economy has managed to stay afloat, thanks to the massive spending by governments. The central banks around the world continue to flood the economies with liquidity and other forms of support for individuals and businesses. The stimulus means relief for the households, and low interest rates mean cheap credit for businesses and home buyers.
“Even with the setback in Victoria, Australia will be a good place to be.” – Mike Hawkins
Australia’s contained COVID environment and resilient commodity prices puts us in a good spot. Additionally, we have more fiscal capacity than most, a well-capitalised banking system and direct leverage to an improving Chinese economy. The Organisation for Economic Co-operation and Development (OECD) has forecasted that Australia's recession will be less severe than expected by the market but its recovery will depend on continuing fiscal support and no return to severe lockdowns. The forecasts assume periodic local outbreaks of COVID-19 will continue, but that there will not be further severe lockdowns.
Treasurer Josh Frydenberg has said it would be imprudent and unrealistic to use the financial 2021 budget to prioritise paying down the deficit and eliminating net debt in a decade, which was the previous budget strategy. It is clear from the Treasurer’s narrative last week that they were taking the surplus narrative out of the forecast period – which is effectively four years. Interest rates are expected to be lower for longer to support the economic recovery and assist governments in meeting their higher-than-ever debt obligations. Even though Australian public debt will jump this year, we are in a much better position than most other countries.
We are navigating the unchartered territory of financial markets via building resilience in the investment portfolios by owning assets that are high quality, have defensive traits and offer risk management mechanism for the overall asset mix.
Infrastructure
Earlier this year, at the depth of the market correction, we took a tactical positioning in global infrastructure assets and have gradually increased our exposure in a few tranches up until last month. Investing in infrastructure assets has enabled us to successfully build strength in our portfolios.
The recurring infrastructure investment cash flows allow for increased predictability in outcomes and minimal impact from the pandemic due to their essential service nature, accommodative regulation, and social importance as major employers. We are also attracted to the positive impact of a potential Democratic sweep in the US Elections on the infrastructure investments.
Gold
We have been using Gold as an alternative asset class, which we believe has a very low correlation with other asset classes and hence acts as a true diversifier. Gold has returned impressive double digit returns in the year to date and have proven to be a great diversification tool in uncertain markets. Even though gold is currently trading at historic highs, we still see merit in holding this precious metal as it may benefit from the elevated market volatility and mounting concerns over the economic impact of COVID-19, as investors seek perceived safe-haven assets.
Quality
We continue to invest in companies who are in control of their own destinies, have competitive advantages and healthy balance sheets to weather the storm. For example, we have recently increased our exposure to Automatic Data Processing (ADP), US listed company not many Australians have heard of. ADP is the largest human resource management company in the world which was founded in 1949 to enable their clients to focus on their core business activities, by freeing up non-core tasks like payroll and HR management services. ADP serves around 800,000 clients in 140 countries. ADP comes with a 45-year dividend streak, one of the best, if not the best in field. The company barely has any debt and has an impressive interest coverage ratio of 30 times.
Bottom Line
No one has a crystal ball for future market conditions. We have never had a health crisis that co-existed with record low interest rates and record levels of stimulus washing around the global economy. Financial markets often dwindle away from the underlying earnings fundamentals on the back of near-term uncertainties like trade wars, monetary policies, and, most relevant in the current environment, recovery from the pandemic. However, we can say with confidence that our inherently conservative investment approach with a high degree of emphasis on capital preservation and the right mix of assets will be rewarding for your investment portfolios.
Last Word – “It requires a great deal of boldness and a great deal of caution to make a great fortune; and when you have got it, it requires ten times as much wit to keep it.” Nathan Rothschild
