Your investment update Q3 2020

Your investment update Q3 2020

This document has been produced by Seven Investment Management LLP from internal and external data. Any reference to specific instruments within this document are part of widely diversified portfolios and do not constitute an investment recommendation. You should not rely on it as investment advice or act upon it and should address any questions to your financial adviser. The value of investments can vary and you may get back less than you invested.

Your Investment Update – ­ Q3 2020

Contents 04

Welcome

Martyn Surguy Chief Investment Officer 06

Strategy The calm after the storm?

Terence Moll Head of Investment Strategy

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Portfolio implementation Asian high yield: From idea to investment Haig Bathgate Head of Portfolio Management

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Featured topic H1 2020: Six months that shook the world Ben Kumar Senior Investment Strategist

Visit us at www.7im.co.uk to find out more about our latest news and views.

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Your Investment Update – Q3 2020

Welcome MARTYN SURGUY Chief Investment Officer

The last quarter was, perhaps surprisingly, one of the strongest on record for the world’s stock markets.

Perhaps they’re telling us that the pandemic is nearly over? Or that the major economies are out of the woods? Or that normal service has resumed in the financial world?

Unfortunately, little can be learnt from recent market behaviour alone. Context is everything. The strong last quarter was preceded by one of the weakest quarters for equities ever. This pattern is fairly typical through history – and is one of the reasons it’s so hard to ‘time’ major investment decisions. Markets can make fools of all of us.

A reality check tells us that the virus is far from defeated and a vaccine remains elusive. Most major developed economies, though, are slowly reopening.

While there are challenges everywhere, stock markets have reacted to incremental positive news about the virus, and about economic recovery. They like the idea of a protracted period of extremely low interest rates.

And they’ve liked the enormous stimulus provided by central banks and governments across the world to counter the crisis.

This leaves investors in a difficult position. Markets have rallied hard, many equity markets are looking mildly expensive, and there seems to be a disconnect with underlying economic reality.

Is it the time to sell and sit out for a while in cash? Unfortunately, moving to cash is a high-risk strategy for long-term investors.

It’s easy to do but very hard to undo as human emotions take over. Investors become ensconced on the sidelines waiting to be proved right and beset by the uncertainties and ups and downs of markets (which are always there).

Your Investment Update – Q3 2020

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We’ve reminded ourselves of our long-term objectives and stayed close to the long-term strategy."

Markets can behave seemingly irrationally for long periods.

In the absence of obvious dislocation and opportunity, it’s far better to trust your fundamental investment beliefs.

It is difficult right now to have much conviction in the shortterm direction of markets.

But we believe in the broad framework and diversification of portfolios that has delivered us safely through crises before.

We’ve reminded ourselves of our long-term objectives and stayed close to the long-term strategy designed to achieve them.

This has been supplemented by adjustments to reflect our optimism about healthcare and European dividends, and our pessimism about government bonds where yields hover around zero.

We expect a quieter second half to the year than the first.

Investment markets are not always exciting and it is in these times we expect portfolio structure and long-term positioning to do the heavy lifting for us. Our Head of Investment Strategy, Terence Moll, provides more colour on this.

Senior Investment Strategist, Ben Kumar, describes our investment journey thus far in 2020, while Head of Portfolio Management, Haig Bathgate, looks below the surface to some of the holdings in portfolios.

I hope that this coming quarter sees us all out and about, enjoying the British summer.

Meanwhile, stay safe and look after your family and friends.

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Your Investment Update – Q3 2020

Strategy The calm after the storm?

Goodbye Wimbledon, cancelled for the first time since the Second World War. Summer this year will not be the same without those two weeks of aces, grunts, celebrity fans and strawberries.

The post-COVID-19 world is a strange place. People are on furlough or unemployed.

Staycations. Children at home needing lots of attention.

WhatsApp and Zoom. We’ve all had to adjust to restrictions and constraints in our daily lives.

Perennial plagues Plagues, like death and taxes, have always been with us. The Black Death may have been the most terrible ever, killing one person in three in 14th century Europe. In one village near Cambridge, seven out of ten people died. The survivors moved away and the deserted village disappeared from the map.

Philip VI of France asked the medical faculty of the University of Paris for a report on the affliction. They concluded that it was due to a triple conjunction of Saturn, Jupiter, and Mars in the 40th degree of Aquarius, said to have occurred on March 20, 1345.

Fortunately, we know a lot more about medicine than those medieval medics. The COVID-19 Open Research Dataset covers no less than 130,000 research papers and provides a mountain of knowledge on the subject.

And yet… we still don’t know enough. We don’t know if people who’ve had COVID-19 can catch it again – in which case, goodbye herd immunity. We don’t know if an effective vaccine is looming, or if it’s a decade away.

And without a vaccine or herd immunity, there could be further waves of COVID-19 in the next few months.

Your Investment Update – Q3 2020

Shutdown and after Most major economies shut down at some stage in March – April, to slow the spread of the virus and give their health systems the chance to cope.

They are bouncing back right now, but the recovery is likely to be incomplete for as long as the virus is lurking in wait for new victims. Moreover, localised shutdowns are possible if it takes off again – just like we have seen in Leicester in recent weeks.

The cost of this will be gigantic.

The International Monetary Fund (IMF) expects the developed economies to contract by a massive eight per cent this year, by far the worst number on record. The world economy is likely to contract by five per cent.

Next year should be much better, but there’s a great deal of pain to overcome first. »

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The 7IM portfolios are positioned for an erratic and uneven global recovery.”

TERENCE MOLL

Head of Investment Strategy

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Your Investment Update – Q3 2020

Strategy Continued

The great coronavirus crash COVID-19 is a human tragedy, and an economic tragedy too. According to the IMF, the world economy will contract by about five per cent this year. That would be by far the worst number in the last 70 years, with global output falling by three times as much as in 2008.

Forecasts

6% 5% 4% 3% 2% 1% 0%

Real World Growth (% p.a)

-1% -2% -3% -4% -5% 1950

1960

1970

1980

1990

2000

2010

2020

Source: World Bank and IMF.

Your Investment Update – Q3 2020

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Governments, in turn, have had to adjust to the reality of COVID-19. We now know the virus is a complicated beast that requires ongoing policy changes and planning, rather than a single, one-off solution.

New Zealand got it right; Brazil is floundering. Most other countries are in between.

Not so simple! We think the recovery will be uneven in most countries. Many households will be cautious about spending, government support schemes for their populations will begin to run out soon, and virus-sensitive activities like airplane travel, restaurants and concerts may not recover fully for years.

The good news is that those economies that brought the virus under control early have been opening up the fastest – like China, the Czech Republic and New Zealand. The IMF thinks that China will grow by one per cent this year. If that materialises, it’ll be its weakest number in forty years… and one of the strongest in the world.

We’re not too worried, though, about later waves of the virus in Europe and East Asia. Health systems are more prepared to manage COVID-19 patients, and treatments being developed give them more ammunition.

Moreover, governments are monitoring the spread of the virus and should be warned if it surges. They’re unlikely to lockdown economies again, but will tighten the social distancing and other rules if necessary.

Curiously, markets have been strong since the third week of March. The FTSE 100 rallied by nine per cent in the second quarter, and other developed markets were up by more than that. Why? Probably because investors expect that the economic recovery will be V-shaped. What falls hard must bounce hard, right?

At the time of writing, the USA is in trouble. The worst-afflicted areas in the northeast, like New York and New Jersey, are under control. But the disease is spreading in the south and west, led by Florida and Texas.

If it becomes endemic in the USA and some developing countries, then the post-1945 story of globalisation, travel and relatively free movement between countries could come under threat.

An uneven global recovery We believe that the global economy will weather the storm and eventually emerge in reasonable shape. But the world will remain distorted by the economic and social impacts of the virus until an effective vaccine is universally available.

The 7IM portfolios are positioned for an erratic and uneven global recovery. With yields ultra-low, we are gloomy about government bonds, and prefer a select group of alternative strategies that are mildly defensive and should earn decent returns over a year or two.

Our exposure to equities is around our long-term neutral. In the US we have a fairly defensive thematic exposure, preferring healthcare companies to the broader index. In Europe we like dividends, which we believe sold off too much earlier this year. Moving east, we like Asian high yield for its exposure to economic growth (see ‘Portfolio implementation’ section).

The IMF thinks that China will grow by one per cent this year. If that materialises, it’ll be its weakest number in forty years… and one of the strongest in the world.”

Terence Moll, Head of Investment Strategy

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Your Investment Update – Q3 2020

Portfolio implementation Asian high yield: From idea to investment At 7IM we are always trying to find new ways to add value to portfolios. In the US, for example, we bought healthcare companies last year, for the long-term growth opportunity they present as people across the world get older and richer and increasingly demand top quality healthcare.

A recent idea is Asian high yield bonds, which we bought in May. Back in April we noted that the potential return on Asian high yield bonds looked to be far higher than those of emerging or developed bonds.

When you invest in credit you are lending money to companies that pay you interest. The higher the chance the company will default, the more interest you earn. The Strategy Team thought that the interest being paid by Asian high yield companies was generous and implied that far more companies would default than we think will be the case.

One reason we like this asset class is that China is a large component of the index. China has handled the global pandemic very well and should recover more quickly, making its companies less likely to default.

By contrast, we do worry about the US high yield sector, since many of its companies might be vulnerable if COVID-19 continues rampaging through the south and west.

Moreover, the Chinese government is more likely to support struggling companies than those in the US or Europe, which also helps explain why its historical default rate on high yield has been low.

After weeks of research the Strategy Team put together a strong case for Asian high yield.

The broader team reviewed the proposal, with lots of frank and critical debate, and agreed that the investment case was sound.

The Portfolio Management Team then had to decide how we invest in Asian high yield. We looked at many factors. We wanted a fund of a reasonable size, so

we could sell our positions if something changed. We analysed performance and looked for managers that appeared to have the capacity to add value.

We then had several videoconferences with our shortlisted managers. These in-depth meetings covered everything from the team, positioning and process, to risk management and company stability. Above all, we want to know how our managers think and make decisions. We need to be persuaded that they are exceptionally good at what they do and have a chance of outperforming in the future.

After extensive analysis, one manager made the cut: the UBS Asian High Yield fund. We believe it will deliver robust returns over the long term.

Your Investment Update – Q3 2020

China has handled the global pandemic very well and should recover more quickly, making its companies less likely to default.�

HAIG BATHGATE

Head of Portfolio Management

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Your Investment Update – Q3 2020

Featured topic H1 2020: Six months that shook the world Clients are often keen to find out how we invest and what drives our decision-making. Let’s demonstrate with a practical example. This year has been an especially interesting case study in how we look at markets and what we regard as important in the long run.

The background is that we believe in diversification. We aim to provide portfolios with broad exposure to the major markets across the world. These longterm allocations drive most of our returns.

We also aim to add value, though, via our Tactical Asset Allocation (TAA), taking advantage of interesting investment opportunities as they arise. In the last few months we have been fairly active in most portfolios, which has added to returns.

I’ve pieced together the picture of the last six months as they unfolded, looking back at our commentaries at the time, records of the meetings we had, and the positions we took, as well as picking some headlines from the papers in each month.

January At the start of 2020, climate change was at the top of the agenda. Front pages of newspapers were dominated by kangaroos and koalas backlit by flames. Late in the month came the Wuhan lockdown, but the disease seemed to come under control quickly.

The 7IM portfolios had no particular tilt towards defensive or growth assets heading into the year, and we made no major portfolio changes during the month.

Your Investment Update – Q3 2020

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We aim to provide portfolios with broad exposure to the major markets across the world.”

February

March

Early February in the UK was Storm Ciara, and the accompanying gales, floods and property damage. Boris Johnson reshuffled his cabinet, replacing Sajid Javid as Chancellor with the relatively unknown Rishi Sunak.

Donald Trump was impeached, but acquitted by the Senate.

Early in March it suddenly became clear that COVID-19 was pretty damn serious. On 9 March, Italy quarantined one quarter of its population. Other European countries began to prepare similar measures. Global equity markets moved around violently, seeing five per cent swings in the course of a day.

By Valentine’s Day, it was becoming clear that the coronavirus was not just a Chinese problem. On 26 February, every newspaper in the UK had coronavirus on its front page. The FTSE 100 lost seven per cent over the next three days.

BEN KUMAR

Senior Investment Strategist

At the end of February, we thought that “the economic impact of coronavirus will be short-lived and contained.” Boy, were we wrong!

Our portfolios performed strongly in the initial sell-off. Our structurally diversified asset allocation delivered as expected, and we made a few further defensive tweaks – trimming our credit exposure and adding a little to government bonds. We postponed rebalancing portfolios for a few days, which added a little to the month’s returns. »

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Your Investment Update – Q3 2020

Featured topic Continued By mid-March, policy responses were beginning in earnest. On 18 March, The Scotsman led with “Chancellor’s £350 billion rescue package to save UK economy.”

There have been few tougher first months in history than Mr Sunak’s. By 23 March the UK was in lockdown and our Investment Management Team was getting used to daily phone calls and videoconferences.

Late in the month we began taking profits on defensive positions and rotated into some of the opportunities we saw.

We sold some of our defensive alternatives, looking instead for strategies to catch the rebound.

We also began buying European dividends and high yield bonds.

April “Johnson in intensive care” was the story of early April.

It’s hard to tackle a pandemic without a leader. Financial conditions started to stabilise, though, as the large-scale job protection programmes calmed nervous investors’ fears of an unemployment catastrophe.

We continued to rotate from government bonds into corporate bonds to take advantage of the higher yields on offer.

On 21 April, for the first time in history, the price of some oil futures contracts turned negative. You would have been paid to haul oil away in a tanker.

We have no strategic allocation to commodities in our portfolios, so this had no direct impact on us. Most equity markets rallied strongly during the month, and at the end of April we trimmed equities slightly – by around 2% in a Balanced portfolio.

May With lockdown in full effect, May was quieter as people across the world settled into their daily rhythms and routines. Headlines in the UK were largely around deconstructing the previous day’s political and scientific briefing.

We did a piece on May 7 titled ‘Holding Pattern’, which summed the month up.

The world began to come to terms with life after lockdown – with some countries further ahead than others in their experience with COVID-19.

China and South Korea showed they were willing to re-impose lockdowns on certain regions if needed, whilst also getting a large chunk of their population back to work and school.

Late in May, we added a position in Asian high yield bonds, which looked more attractive than their US equivalents, partly given the differences between the responses to COVID-19 (see ‘Portfolio Implementation’ section).

June The easing of lockdown continued in June. In England, non-essential shops began to open on 14 June, while in Scotland it took until the end of the month. Queues on the pavements on the first day of easing led to predictions of a sharp economic recovery.

But we’re more cautious. While household bank accounts have swelled by around £55 billion between March and May, this money needs to find its way back into circulation to avoid an extended recession. Many people are fearful about the future so spending will probably return in a trickle, not a flood.

It’s now early July, and the 7IM portfolios are positioned for an erratic and uneven global recovery over the next six months. Our exposure to equities is around long-term neutral, with some themes like healthcare adding defensive qualities, but others like Asian high yield giving exposure to economic growth.

Your Investment Update – Q3 2020

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Our structurally diversified asset allocation delivered as expected, and we made a few further defensive tweaks.�

Our TAA changes over 2020 This chart illustrates how our tactical positions on a Balanced risk profile evolved over H1.

Each set of TAA changes is shown. Note how March was a busy month for TAA, with portfolios changed seven times, reflecting wild markets and the opportunities that were arising. By contrast, there were no TAA changes in February and only two changes in May. UK Equity

100%

North America Equity

90%

European Equity

80%

Japan Equity Emerging Market & Asian Equity

70%

Global Government Bonds 60%

Gilts Global Corporate Bonds

50%

Global High Yield Bonds 40%

Emerging Market Bonds

30%

Convertible Bonds Inflation Linked Bonds

20%

Real Estate Alternative Strategies

10% 0%

Risk Mitigation Jan

Source: 7IM

March

April

May

June

Cash

Meet the teams Investment Management Team Martyn Surguy Chief Investment Officer

Tony Lawrence Senior Investment Manager

ACA Chartered Accountant, MCSI, CISI Level 4, 30 years of industry experience.

CFA and CAIA, 18 years of industry experience.

Terence Moll Head of Investment Strategy

Christopher Cowell Investment Manager

M.Phil. Ph.D. in Economics, 28 years of industry experience.

PhD in Biochemistry, MSc Molecular Biology, 4 years of industry experience.

Haig Bathgate Head of Portfolio Management

Jack Turner Investment Manager

CFA, 22 years of industry experience.

CFA, 10 years of industry experience.

Camilla Ritchie Senior Investment Manager

Ahmer Tirmizi Senior Investment Strategist

IMC, 30 years of industry experience.

MSc in Economics and Finance, 12 years of industry experience.

Peter Sleep Senior Investment Manager 29 years of industry experience.

Stephen Penfold Senior Investment Manager 35 years of industry experience.

Matthew Yeates Senior Investment Manager CFA / Certified Financial Risk Manager, 9 years of industry experience.

Duncan Blyth Senior Investment Manager CFA, 22 years of industry experience.

Ben Kumar Senior Investment Strategist CFA, 9 years of industry experience.

Harriet Massie Business Manager Level 3 Candidate in the CFA program, 4 years of industry experience.

Katy Stoves Investment Analyst CFA, 10 years of industry experience.

Risk Team Joe Cooper Head of Risk and Portfolio Analytics CFA / MSc in Applied Economics, 10 years of industry experience.

Alex Mitsialis Performance and Risk Analyst MSc / CFA, 5 years of industry experience.

Aaron Chhokar Investment Risk Analyst MSc / MEng 2 year of industry experience.

Hugo Brown Risk Analyst BEng, 2 year of industry experience.

Haris Slamnik Risk Developer Risk Developer, MSc, 2 year of industry experience.

www.7im.co.uk Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority, the Jersey Financial Services Commission and the Guernsey Financial Services Commission. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales number OC378740.