SWFs Need to Re-examine Their Charter During 2020

The SWF legal status is key since it impacts the fund’s form, governance, links between actors and applicable law. With many effects of the coronacrisis still to unfold,  previous provisions may no longer be relevant.  A revision in legal status should consider Santiago Principles to promote improved governance, foster accountability, ensure transparency and instill prudent investment practices.

2-swf legal status

Oil Markets Have Completely Changed During Coronacrisis

Price of oil drops to historic lows. Lower economic growth, slowdown, and other factors reduce interim term demand. Given travel restrictions, positive effects of stimulus on oil demand to be minimal. Crude oil supply increase in the short term to keep global crude oil prices at multi-year low in 2020.

oil

Market Volatility – VIX at 47 – Matches Average Crisis Period Uncertainty

Equity markets volatility still high  – twice historical average – of last decade. For Q1 2020:  Lowest  12 on January 17. Highest 82 on March 16. Q1 Average at 31. 47 on April 7th.  Shorter-term VIX futures trading at  premium to longer-term contracts suggesting more volatility in future and buying opportunities on dips.

vix

History Lesson: How Did the 2008 Crisis Spread in the U.S.?

History never repeats itself but does it really rhyme? As one who lived through the 2008 global financial crisis I have been reflecting on ‘those who cannot remember the past are condemned to repeat it’.  To seek lessons, I recreate the broad building blocks of the ’08 crisis. The contagion, the transmission mechanism as well as government interventions. The financial crisis was a lot more complex than the coronacrisis. This visual built off my research, that I hope to expatiate on forthcoming, speaks a thousand words.

How did the 2008 crisis spread in the US

 

Equities Cheapen Providing Entry Points During Episodic Drops in 2020

Bull market has ended, and volatility is at all time high > 45 in April. Government fiscal stimulus in CARES Act and supportive monetary policy to provide catalyst during recovery period. Low interest rates are supportive. Overseas stocks now have lower P/E and higher dividends than US stocks. Growth prospects between Emerging and U.S. diverge. Trade weighted dollar value to decline as Covid-19 crisis plays out.

equities cheapen

All Equity Sectors Performed Poorly in 1Q-2020, Albeit with Wide Variation

Energy, financials, materials and industrial performed worst, ostensibly reflecting oil price reduction and demand slowdown. Utilities, staples and healthcare provided relative resilience as expected. Sector beta to S&P 500 in line with intuition, foreign sales component in line with history, P/E as historical except for energy.

q1-2020 sector performance

SWFs Need Re-examine Established Investment Process and Permitted Investment list in 2020

ActiveAllocator Research: After the market debacle and expected pronounced volatility, existing investment processes need an overhaul. This includes reflecting changes (downgrades) in country ratings and lists of permitted investment.

1swf-investment process

High Yield Bond Spread-to-Worst Increasing Dramatically In April 2020

HY Bond prices dropping. Rating down grades and default rates to increase dramatically. Spread-to-Worst indicator – difference between the yield-to-worst of a bond and yield-to-worst of  U.S. Treasury, measuring dispersion of returns between the safest and worst security – rises.

Spread to worst

Recession in Q2-2020 Ends Decade of Expansion

Synchronized global shut down of economic activity. All components of economy affected, albeit unequally. Q2 2020 U.S. real GDP growth estimated at -34%, annual -6%. Global  annual GDP to shrink -1%. Length and depth of recession to be dependent on scope of pandemic. Recovery depends on vaccine development, therapeutics and efficacy of social distancing measures.

recession in q2

 

Will $2 Trillion Support Combat Economic Halt?

ActiveAllocator Research: CARES ACT averts temporary disaster and provides respite to individuals, companies, state and local governments. “Stimulus” is expected to rise to US$3 trillion as the pandemic unfolds over 2020. Will set inflationary pressure and result in likely higher interest rates, as accumulated deficit rises.

willl 2 trillion stimulus avert disaster

Unemployment Climbing To Record High 15% In April 2020

Jobless rates at over 15% and rising at unprecedented rate, unmatched in American history since 1933. 20 million unemployed as economy shuts down. Unemployment insurance and jobless claims climbing through the roof. Poorer sections – around 19% unemployment in African American- being dis-proportionally affected during Covid-19 crisis. Retail, restaurants, travel, hotels, airlines and leisure industries losses spreading. Oil and gas companies laying off workers as oil prices collapse.

4-Unemployment Rise

Federal Reserve Has Been Proactive in Usage of Monetary Policy Tools

Quick rates cuts, quantitative easing, asset purchases and balance sheet expansion provides liquidity, funding and access to credit. Supportive monetary policy includes credit facilities for money market funds, primary dealers and commercial paper as well as enhanced swap facilities with other central banks.

Slide3

Social Distancing Arrests Spread But Exacts Economic Toll

ActiveAllocator Research: Service industries such as leisure, entertainment, food services and retail sectors to be worst hit which increases unemployment. However, these are a small percent of overall GDP and corporate earnings. U.S. equities enter bear market territory, government bond yields drop, oil prices collapse, unemployment rises.

Slide2

Gettysburg Address

Never since 911 has our city experienced so much trauma. I extoll the sacrifices of those – medical workers, doctors, nurses, public servants and everyone else – who bravely stand at the front-lines defending us citizens from the dreaded Coronavirus. We, a grateful nation, salute your courage.
To your devotion to your country and to your profession, I recite the Gettysburg address from memory.

Large Business Health in 2020: What Do Markets Tell Us?

Survey and anecdotal evidence hint that economic activity is slowing more quickly than had been generally perceived. Data from the markets highlight huge decrease in corporate sector revenues and earnings. We may be another 12-18 months before earnings start to pick up. In parallel, defaults from the public bond markets (for lower rated companies) and the syndicated loan markets are going to increase a lot. The economic outlook is grim. I know you too will find this visual sobering.

big business health1

 

 

A bailout by any other name is still a bailout.

Prudent government intervention to support a fragile banking system in 2008, is still vociferously attacked and characterized by many as a sell out  to Wall Street greed. The CARES Act now provides US$2 Trillion relief to individuals, businesses, states and other actors. Yet, ostensibly because bulk proceeds go to Main Street participants, I don’t hear a single dissenting voice! As one who had a front row seat on Wall Street  and helped shape response to the 2008 financial crisis, I find this rather hypocritical. A bailout by any other name is still a bailout, and I bet Milton Friedman would agree!

The amateur financial historian within me, led me to take inventory of major government interventions then – the major types of action taken, affected companies and governments rationale. I hope this sets the record straight so that we can compare it with the Cares Act. I hope you find this visual useful.

bailout1

 

Equity Markets Peak to Trough Draw-down Highest in March 2020

ActiveAllocator portfolios are designed to be resilient to maximum draw downs- and that’s exactly how it played out for us in March.  Examining markets performance in hindsight does not reveal too much for one arbitrarily selects a period to measure –  random entry and exit points in an hour, day, week, month or years. Since none of us can time markets ex ante, I calculated the maximum peak to trough decline in all equity markets across the world, and in all sectors, across different time horizons. In other words the maximum amount an investor could have lost.

Anyone who had exercised a put option, or shorted these sectors with perfect foresight,  would be laughing all the way to the bank today! I present the maximum sector draw down in a visual.

march drawdown

Russia and Eastern Europe Government Responses in 2008. What about 2020?

Russia so far has been spared rising Coronavirus infections, but that seems to be changing today with 1,836 cases reported and nine deaths. Which begs the question why have Russia and other Eastern European countries not announced plans for economic stimulus to the imminent fallout? One reason may be that sanctions have insulated Russia from global markets, unlike in 2008 where its banks were deeply entangled with the Western banking system. At that time Russia and Eastern Europe made decisive proactive interventions. This led to banking systems recovery providing the strength to fulfill their role in the economy: that of providing funding to individuals and business.

While recognizing that this crisis is nothing similar, I still think it useful to calibrate the government response at that time to provide a sense of scale – captured in this visual.

eastern europe response

SWFs Need Re-examine Established Investment Guidelines in 2020

Sovereign Wealth Funds (SWFs) have lost hundreds of billions of $ ever since the Coronacrisis gathered speed. Revising Fund’s investment guidelines is vital to repairing the damage done. A wait and hold approach is hardly prudent. Such guidelines are going to be a key decision for it both flows from as well as impacts the fund’s form, governance, links between actors and the applicable law. I believe that investment guidelines should follow from the basic principles and core values of the Fund, as well as its general entrusted mission.

revise investment guidelines

 

SWFs Need Re-examine Historic Institutional Framework in 2020

Sovereign Wealth Funds (SWFs) have in March 2020 alone, cumulatively lost hundreds of billions of $ in citizens accumulated wealth. Attributing this to adverse market movements is hardly an excuse. I observe that most SWFs have been on ‘auto pilot’, driven by inertia after they were formed. Meanwhile much has changed in their external and internal country environments. This naturally has ramifications on the legal framework within which such vehicles now operate, as well as their initial objectives and macroeconomic linkages with national economies. This in turn influences their investment policies and risk management frameworks.  In my view the Coronacrisis should catalyze fundamental rethink of a Fund’s institutional framework and governance structure.

I believe that this is a good time for soul searching. For whether a SWF is placed under the supervision of the Ministry of Finance, or the Central Bank, or is run as an independent entity has enormous importance going forward. Something that I highlight here, as well as will build upon in subsequent postings.

institutional framework

 

SWFs Need to Radically Revamp Risk Management Process Now

Sovereign Wealth Funds (SWFs) have lost hundreds of billions of $ ever since the Coronacrisis gathered momentum, beginning March. I believe it the largest destruction of accumulated citizens wealth in history. Having advised multiple SWFs I am acutely cognizant that each has its own specificity, governance, asset allocations, risk levels and special objectives. A Fund’s institutional framework too has great influence over managers, both internal and external, and therefore has an impact on its management and returns. A SWF’s legal status also is a key decision point,  since it impacts the fund’s form, governance, links between actors and the applicable law.

I am of the view that recent market events highlight the importance of managing risk holistically even more so.  I draw attention to five issues in this visual.

Sovereign Wealth Funds - risk process

SWFs Need to Revisit Objectives During Coronacrisis

SWFs Need to Revisit Objectives During Coronacrisis

I hold the view that nations that have already set up a Sovereign Wealth Fund (SWF) now ought to revisit every aspect – the mandate, mission statement: the very objectives of the Fund, the institutional and legal framework, the way it should manage and monitor the investment process going forward, investment guidelines that may no longer serve well, risk management/ benchmarks, the governance framework, the optimal mix between internal and external managers as well as myriad of issues including evaluation and performance assessment. Recent huge losses suffered may itself generate a public debate on topics of investment of “excess” reserves, the level of future risk and more important spill-over implication for macro-economic policies.

I believe that the more transparent and the more professional they are, the more open will be capital markets and their own citizens to their activities. We present a visual by way of catalyzing conversation.

revisit objectives during coronacrisis

Corona Crisis Impact on Large Business: 10 Recommendations

Now that the $2 trillion coronavirus relief package has passed 96-0 in the United States Senate I am confident it will soon get through the House.  The proposal includes $500 billion in loans for larger industries. I did read somewhere that one out of every five companies now is a zombie company  –  the walking dead, that earns just enough money to continue operating and service debt, but is unable to pay off their debt. The planned $500 billion Treasury Department fund would be subject to scrutiny via public reporting of transactions, as well as a new dedicated watchdog and accountability committee. The package won’t likely help them and I expect a rise in bankruptcies.

Here are Ten Commandments that responsible CEO/ CFOs and corporate boards may benefit from.

10 commandments

 

 

 

Global Central Bankers Survey – February 2020

I had polled global central bankers in January/February – around 47 OECD and non-OECD banks participated with multiple respondents each to the survey.  While the names of the banks are known (albeit concealed as I don’t have permission to reveal)  the respondent profile was anonymized to ensure better disclosure. At that time I did not sense the severity of the impending Coronacrisis, so questions related to it were not asked – a mistake I feel, in retrospect.

Attached is an excerpt.

Central Bank Survey1

Bank Balance Sheet Restructuring Likely to Be Complex in 2021

What will happen in 2021? While governments will stand behind banks as the Coronacrisis unravels, most banks will be left in a weaker position when all this ends. Ultimately, only governments will provide the multi-stakeholder leadership, the trust and the huge balance sheet to back banks. Guan Seng Khoo, PhD and me recommend that banks need to now begin to build capital (and cut balance sheets) from recent levels, take account of an expected increasing level of loan losses, not just from problems emerging to date but from risks of a possible “ credit crunch”, likely over the course of a developing economic down-turn.

Guan Seng Khoo, PhDbank bs restructuring 2021 and me have thought through a hypothetical scenario of how the banking sector may need to restructure their balance sheets. We present our thoughts in this visual.