As investors reflect on recent market events surrounding the coronavirus, oil market turmoil, lifting of shutdowns, and events that have yet to unfold, they are contemplating what all this means for how they should invest. Avoiding rash decisions that are driven by fear or greed and sticking with a well-laid plan are at the top of the list. Equally important is working with partners who have the experience and discipline to put current market conditions in context and who can help investors successfully navigate new risks and opportunities that are emerging across capital markets. We asked senior investment leaders from Wells Fargo Asset Management to succinctly comment on the role that active management plays in times like these. Their responses are shared below.
It may not come as a surprise to readers that U.S. equity markets have recently gone through the steepest sell-off and rebound in volatility in recorded market history. Similar to prior downturns and recoveries, rising price correlations among stocks reflect the tendency for markets to ignore differences in fundamentals. Options markets are suggesting that volatility is expected to remain elevated for the foreseeable future. However, price discovery is returning. Past experience has shown us that as the real economy and all its participants begin to settle into a new equilibrium and eventual recovery, the benefits of actively identifying winning and losing business models tend to return.
There are many companies that face significant challenges, particularly in the energy sector and in areas that are fundamentally incompatible with emerging social distancing norms, such as travel and entertainment. I’m anticipating that some of the weaker hands in this space may not survive in their current form—but there will almost certainly be survivors. Many of the business models that are now more clearly emerging as winners are those whose management teams have already prepared for change—specifically, I’m thinking about companies in nearly every business sector, including those that face the brunt of current challenges, that have proactively used technology to streamline their operating models and enhance the core competencies that have historically driven their success. These companies have more ways to protect their earnings power in difficult times. Together with strong balance sheet fundamentals, I expect the near future will provide many opportunities for well-run companies to profitably expand. For us, our experienced fundamental equity teams also have been proactive in their preparation for change, finding new ways to streamline our business and actively seek insight in the investment process. I like to think of this as mimicking the best practices employed by the companies we invest in.
Jon Baranko, Deputy Chief Investment Officer, Wells Fargo Asset Management
Recent volatility in fixed-income markets from the coronavirus and oil-related shocks has created significant price dispersion across sectors and maturities and among individual securities, setting up a broad and fertile environment for security and sector selection. The migration of credit across the traditional fault line separating investment-grade and below-investment-grade bonds (BBB-rated versus BB-rated) is one notable area of price dislocation. Rating agencies tend to dictate the composition of indices and are often reactive to corporate events in revising ratings. Moreover, credit indices tend to emphasize the naturally high levels of issuer concentration in bond markets. For example, the recent downgrade of Ford Motor Company from BBB to BB status is sizable enough to have meaningfully contributed to index-level performance. This environment is setting up well for active managers to anticipate negative or positive credit migration—so-called falling angels and rising stars—before the more passive participants.
Another important area of dislocation is in bond market liquidity. Issuers have been seeking to raise liquidity by drawing down their revolving credit lines with their banks and bringing record levels of issuance to investment-grade markets—March alone saw approximately $260 billion in new supply. Investors in traditionally more liquid segments are asking for and receiving significant price concessions to absorb this issuance. Liquidity in the high-yield and distressed debt space has been much lower, providing significant premium and selection opportunities for market participants who have a more opportunistic mandate and are able to research and engage in price discovery.
The swift implementation of monetary stimulus and direct market support to corporate and municipal markets has reduced some of the immediate fallout—acute liquidity risks are beginning to ease, though credit risks are heightened and will likely remain so through the intermediate term. We are identifying some of the more lasting implications of a post-pandemic world on certain sectors, including commerce, leisure, and manufacturing, among others. Changes in consumption patterns and employment will also likely take on some level of permanence as the real economy adjusts. The structural nature of these changes will require some real forward thinking. I’m confident our global credit research platform will help us navigate this dynamic environment and uncover what I believe will be very significant and attractive opportunities for our investors going forward.
Dr. Brian Jacobsen, CFA, CFP Senior Investment Strategist, Multi-Asset Solutions
The financial media tends to draw a bright line between active and passive management. But, as solutions providers, we weigh the pros and cons of the various ways to get the exposures we need to build and manage portfolios. And in truth, whether we use an active manager, an index tracking fund, an exchange-traded fund, or a financial derivative, we are making active decisions as to how to best implement in order to meet our clients’ needs. The underlying calculus in these decisions is always, “what is the most efficient way to gain the exposure that increases the probability of achieving the client’s goal?”
Trending markets tend to hide the differences among securities in both their specific risk exposures and their supporting fundamentals. Sudden reversals and market dislocations then tend to exaggerate the importance of these differences and provide a catalyst for a correction in relative values. Sometimes those market dislocations are at a very large scale across asset classes where we want to express a view with exposures that track a broad index. Other times, those dislocations manifest within asset classes. That’s when we look for active managers who understand their markets well enough and who have the proper conviction to proactively seek the best opportunities. For us, it’s never a simple either/or proposition between active and passive but more a question of the right mix. In today’s environment, where we are seeing large-scale disruption to economic activity across countries and within industries, we think it’s the right time to remember that active and passive can coexist very nicely within portfolios. Our active managers recognize that both life and the economy are changing in major ways and that they have the responsibility to understand how things are changing and to position portfolios in line with that vision with high conviction. Ultimately, their utility can shine in markets like we are experiencing now.
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