Market Commentary November 2020
Covid-19 vaccine drives markets higher
On 9th November, Pfizer announced the creation of a successful Covid-19 vaccine. Although this was a slightly tricky vaccine to transport and deploy, requiring storage at -80c, markets around the world reacted with unbridled enthusiasm, and countries and stocks that had been the hardest hit, rose strongly on that day. This announcement was followed fairly quickly by two more, including the Moderna and Oxford vaccines, which do not require special handling, and can therefore be deployed more quickly and easily.
Biden victorious in US presidential election
After another tiresome wait for a US election result to be confirmed, Joe Biden emerged as the next president. At 78, when he enters the White House, he will be the oldest man ever to do so. With this, and the Democrats having failed to win the Senate, it is not clear that a second term for Biden can be assumed, but for the moment, the market was content to breathe a sigh of relief and look forward to more stable international relations, and a return to post-pandemic normality sometime in 2021.
Brexit trade agreement sentiment waxes and wanes
After ending October on a negative note, sentiment, as measured by the strength of Sterling, rose during November, as investors looked to the EU summit on 19th November for some positive news on a trade agreement. In the event, positive news was in short supply, and tensions were once again beginning to escalate as the month drew to a close. The deadline for a deal is the end of the year, but in practice, allowing for Christmas and time for all EU nations to approve any proposal, time will effectively have run out by the middle of December.
Japan continues to power ahead
Japanese stocks continued to be among the best performers outside of Europe in November. The Nikkei 225 rose by some 15%, whilst the TOPIX gained just over 11%. The Japanese market continues to benefit from the appointment of the new prime minister, Yoshihide Suga, who is expected to roll out his own, improved version of Abenomics. Shares were also buoyed by the Democrat win in the US election, with hopes that an easing of the Sino-US trade dispute may now be more likely. This has led to a growing feeling that now might be a good time for many investors to revisit the Japanese market.
Equity markets were cheered, early in the month, by a seemingly decisive Biden victory in the US election (notwithstanding objections from the incumbent president), and shortly thereafter, the announcement of three proven Covid vaccines awaiting approval. Early indications were that they could (once approved) be rolled out quickly and this led to hopes that life, and the global economy, might start to return to normal in Q1 2021, and investors were quick to start bargain hunting in sectors that had been hardest hit by the pandemic, including oil, airlines and restaurants, some of which saw rises of 30% or more during the month.
European stocks, which had been hit hard by the second wave of lockdowns, were among the biggest risers, with the major EU markets showing strong double-digit gains, led by Spain, which rose by more than 25%. Only a handful of emerging European markets saw losses. The UK was, once again, the laggard, by a wide margin, hampered by stronger Sterling, but still returned a healthy 12.4%. The good news on a Covid vaccine was not enough to bury completely the concerns over the impending deadline for a Brexit Trade Agreement with the EU, and news flow on this became progressively less encouraging as November wore on.
A combination of stronger Sterling and a weaker dollar saw the cable rate rise by another 2.9% in November. The dollar continued to be volatile, with substantial swings in demand driving the currency lower overall for the month. Sterling, conversely, continued to act as the key barometer of sentiment over Brexit trade talks, and was driven steadily higher ahead of the EU summit on 19th November, with hopes that a deal could be agreed.
10-year yields in the major markets were mostly lower in November, with the exception of the UK and leading EU nations. Globally, all sections of the bond market gave positive returns, with High Yield the best performer, and the higher quality global government bonds giving a much more sedate gain, which became negative for Sterling investors due to the strength of the pound.
*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.
The rise and rise of ESG (Part II)
Earlier in the year, we wrote about the growing popularity of ESG funds among investors, and described some of the approaches taken to ESG investing. This month, as we prepare to draw a line under one of the most unusual years in market history, we will look at some of the benefits and pitfalls of ESG investing, and what you actually get for your money.
It is probably no surprise that the growth in interest in ESG investing has coincided with a period during which ESG funds have done relatively well. The FT reported, in June, that most ESG funds had beaten their non-ESG peers over the past decade (“Majority of ESG funds outperform wider market over 10 years”, https://www.ft.com/content/733ee6ff-446e-4f8b-86b2-19ef42da3824). However, as we continue to see with index trackers, when money is trending into an area of the market, that area, grows, attracts more attention and generates more column inches in the press. Popularity, in investment at least, would seem to be its own reward. And, as we have seen with the technology sector this year, regular savings into thematic or index-tracking vehicles can see a great deal of money flowing into the same stocks, sometimes driving them to valuations that would make an active investor blanch. Tesla shares have continued to rise to a P/E of more than 800x, due to the constant inflow of passive money. (we have previously highlighted the egregious environmental damage caused in producing batteries for electric vehicles).
But has the good performance of ESG stocks really been due to their ESG credentials? Well yes … and no. The type of company that is favoured by ESG funds will have a sustainable business model, be well-governed, and steer clear of controversies such as child labour, heavy pollution and discrimination lawsuits. However, this does not mean that non-ESG funds actively seek out poorly run companies that have unsustainable business models and are forever defending themselves in court. So isn’t ESG investing just best practice? That would certainly seem to be the roadmap that the industry is following, and there is now a general consensus that, in the future, some form of ESG rating will be required for any fund to be marketed in the UK. The key to explaining the variations in performance between ESG and non-ESG funds lies more in what they do NOT hold.
Two of the most common exclusions from ESG funds are oil and tobacco. For many, if not most ESG funds, the quality of the management of these companies can never outweigh the damage they do to the environment and public health, hence most ESG funds will hold no oil or tobacco companies. The chart below shows how the largest (UK) oil and tobacco companies have performed over the past ten years, versus the All Share Index:
It stands to reason that funds that are structurally unable to hold these stocks have done better than the broader market. It is also the case that ESG funds will not fare so well, in relative terms, when oil and tobacco companies are in the ascendant, but either way, the clear message is that ESG funds do not simply offer a pared-down version of their non-ESG peers; they represent a very different proposition in terms of risk and reward. This is true, even where an ESG fund is a true subset of its non-ESG parent, i.e. where a manager offers both versions of the same fund.
Conversely, ESG fund tend to be overweight in many areas of technology, such as security software, clean energy, communications and healthcare technologies. These have all participated in the strong rise in the tech sector that we have witnessed this year. This has not, for the most part, been due to their ESG credential, but because of factors related to the Covid-19 pandemic, which has seen shares rise simply because a company does not rely on a face-to-face business model.
Another facet of ESG investing is that the fund universe has, until recently, consisted primarily of plain, long-only equity funds and bond funds. These give the investor full directional exposure to the asset class, with no real downside protection. In particular, risk-averse ESG investors have had little scope to invest in the more niche and specialist vehicles that we would typically include in the core of a wealth preservation mandate. Strategic and dynamic bond funds, short-dated bond funds and absolute return funds have, until very recently, been conspicuous by their absence, meaning that whilst ESG models have generally performed well, they would have enjoyed little stabilisation or downside protection if the global markets had continued downward, rather than bouncing as they did in April. The past couple of years have seen a number of interesting and differentiated ESG vehicles, both active and passive, launched, but, to date, most of these remain below what we consider to be a critical AUM size. Also, unless they have been spun out of a non-ESG parent, using the same methodology, they do not yet have an appreciable track record to analyse. From this perspective, ESG investing still has some way to go before it is truly mainstream.
Notwithstanding all of the above, we at Collidr have been working on ESG and ethical funds for more than ten years, working with fund managers and investment firms to develop our own framework for evaluating ESG quality in the funds in which we invest. We believe that ESG ratings will be a major consideration in the years ahead, and our in-house analysis, based on our own research and interviews with the Fund Managers, seeks to uncover just how ‘integrated’ ESG considerations are in the investment process of the funds that we use. This applies not only to funds that are described as ‘Ethical’, ‘Sustainable’ or ‘Responsible’, but to all the funds that we cover, of all types. We operate a scale of 1 – 4 for ESG (intentionally an even number to remove the temptation to rate funds as the middle value – we don’t sit on the fence). Those that claim awareness of ESG, but show no real follow-through in their evaluation of companies will not score well. Those that score 4/4 are the ones that can demonstrate original thought, analysis and structural integration of ESG into their investment process, and can cite specific disagreements and documented decisions. We also look for evidence that the ESG analysis can actually block an investment, or cause it to be sold.
Disclaimer: The information contained in this report is for illustrative purposes only and should not be construed as a solicitation nor offer, nor recommendation to acquire or dispose of any investment. Specifically, the share class used to create the illustrations may not be available on all platforms nor be suitable for individual investors. This report was produced by Collidr Research (“Collidr”) for Affinity Integrated Wealth Management (AIWM) and while AIWM and Collidr use reasonable efforts to obtain information from sources which they believe to be reliable, neither AIWM nor Collidr make any representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are subject to change without notice. Model returns are calculated using the most appropriate share class of the underlying funds, having regard to the illustrative nature of the report, with all income being reinvested. As a result, real portfolio performance may vary from model performance. Where model portfolio histories are shorter than three years, historic model returns are substituted prior to inception date with returns from an Collidr performance benchmark. This benchmark is constructed from the average returns of all Collidr portfolios with similar risk profiles that existed during that time. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. Affinity Integrated Wealth Management is a trading style of Buryfield Grange Limited, Buryfield Grange Life Planning Limited and Affinity Integrated Wealth Management Ltd. ‘Buryfield Grange Limited’ is authorised and regulated by The Financial Conduct Authority. Not all services provided by Buryfield Grange are regulated by the Financial Conduct Authority. ‘Buryfield Grange Limited’ is registered in England and Wales at Inspire House, 20 Tonbridge Road, Maidstone, Kent, ME16 8RT. Company registration number 4568338. Collidr Research is a trading name of Collidr Technologies Limited, registered in England and Wales at 34 Southwark Bridge Road, London, SE1 9EU. Company registration number 09061794. Data Providers: Bloomberg L.P. and Collidr.