As Covid-19 swept the globe in 2020, its effects were clearly devastating on the lives of individuals and businesses.
The ripple effect will likely continue for some years to come, not least on economies and markets.
What we see today is a rather volatile market. This shouldn’t be too much of a problem if investors are in the early or even mid-phase of their investment journey, but to those in the decumulation phase, many are facing not just a capital loss but (by proxy) a reduced level of income in retirement.
The issue with volatility is often not knowing when it will occur or when it might stabilise. As Donald Rumsfeld once famously put it, there are known knowns, known unknowns and unknown unknowns.
This is particularly pertinent in financial markets and even some of the most accomplished investors can and have come unstuck when certain ‘unknown unknowns’ rear up. Coronavirus is one such example and both markets and investors have felt the full effects of the ensuing volatility.
As multi-asset investors (in the case of the Tenax Absolute Return Strategies Fund), we know all too well the importance of risk management and of managing volatility; it is very much part of our DNA.
To our minds, in the decumulation phase of life, a successful strategy must provide low volatility returns in order to avoid stripping out capita, which, in turn, reduces income. The process is known as ‘pound cost ravaging’, where retirees are forced to sell larger and larger portions of their pension pot to maintain their preferred level of consistent income when the underlying value of that pot falls. As such, the best funds will be mindful of the risks to capital to avoid the worst extremes of market volatility associated with those risks.
The big question is, in this environment, how can investors navigate markets to avoid high volatility and even the permanent loss of capital in retirement?
The answer is simply to focus on low volatility returns through steady investment instruments. By way of example, throughout 2019 and into early 2020, the managers of the Church House Tenax Absolute Return Strategies Fund (Tenax) watched credit spreads tighten to levels last seen in mid-2007. We didn’t anticipate the pandemic but did anticipate an ‘event’ that would see spreads gap out again, causing a spike in volatility across all asset classes (and a consequent buying opportunity).
By the end of January 2020, Tenax had 69% of its portfolio invested in money market instruments, having sold most positions in risk assets as 2019 progressed. Then, we waited eagerly and when the eventual spike in volatility came, most obviously on March 23rd, creating plentiful miss-pricing opportunities, we were like ‘kids in a candy store’, able to deploy the cash for the benefit of the Fund and its investors.
Managing up the allocation to money market instruments had protected the value of investments while the subsequent buying opportunities allowed the Fund to make sufficient gains to sustain withdrawals without affecting the capital value. In fact, growth stood at 4% in 2020.
Even as this was playing out, the fund managers had to remain mindful that there are always risks to capital and that the shifting sands of global economies, poised as they are for strong recovery on the back of continued profligacy by central banks and governments, have now brought the spectre of resurgent inflation to the surface with consequent disquiet in government bond markets - principally the US and UK. Government bond yields in those two countries have spiked recently, raising concerns that interest rates, for so many years on a downward track, might finally be about to turn upward, and maybe even quite sharply. Gilts and longer duration corporate bonds have sold off in January and February 2021 and many fear it is only the beginning.
Bond markets also face the looming threat of inflation and, in this environment, it is worth remembering that as interest rates have been falling since 1992, there are a great many money managers who have never seen a rate rise and who cannot contemplate higher inflation.
Fortunately, for investors, the managers of the Tenax Fund are able to draw on long memories and have already positioned the Fund so that 33% is allocated to AAA Floating Rate Notes (FRNs) and a further 37% to sterling corporate bonds with an average duration of just 2.7 years. The interest or coupon from FRNs, as the name implies, rises and falls with movements in interest rates, so as interest rates rise, so do they. This is quite unlike other bonds, the capital value of which will fall as interest rates rise. So, FRNs essentially provide a free hedge against rising rates. Similarly, longer duration bonds are most vulnerable to rising rates so maintaining short duration is a sensible strategy for an absolute return fund trying to protect capital and provide withdrawals for SIPPS in drawdown.
For growth, governments in many countries, notably the US, have outlined extensive infrastructure spending as a means by which to kick-start their economic recovery, so that seems another sensible area in which to invest and Tenax has 6% exposure to the asset class. Our 10% allocation to equities includes investments in mining stocks and financials that have historically benefited from rising inflation, while UK REITs offer recovery opportunities through the likes of Shaftesbury and Land Securities.
As is always the case with decumulation funds, it is the combination of exploiting mis-pricing opportunities to generate upside participation and defensive assets to limit downside participation that create the low volatility of returns essential to sustain withdrawals without stripping out capital.