Reporting by Isaac Codrey, CFA
Many asset classes and securities that were perceived to be liquid frankly froze in mid-March. Liquidity in this instance means an adequate number of willing buyers and sellers. Liquidity issues were visible in both equity and bond markets. It wasn’t only risky securities that were experiencing issues but “safe” assets too. Those individuals looking or needing to sell corporate or municipal bonds, for example, likely would have had to do so at 5-10% haircuts to intrinsic values. This is the “damaging” that we are referring to above.
On the other hand, U.S. Treasury bonds, perhaps the most loathed asset class due to the paltry yield, remained liquid. If clients needed cash in March and April, U.S. Treasuries were the preferred first line of defense. While the current yields are tough to swallow and do not provide much in the way of real returns, we were reminded of their virtues from a portfolio management perspective – liquidity
and negative correlation. In times of ultimate stress, when asset classes depreciate in unison, it is often only U.S. Treasuries that are appreciating in value and providing diversification to the rest of the portfolio. As a result, while we typically only allocate a small percentage to U.S. Treasuries, this period confirmed the benefit of that portfolio management practice.
Finally, the corporate level… Probably never in the modern history of developed economies have so many businesses (restaurants, hotels, cruise liners, airlines, gyms, movie theaters, theme parks, etc.) experienced sales dropping to essentially $0 and, thus, short-term liquidity has never been so important. Those with adequate cash to pay bills should survive and those without liquidity will likely not. As a result, bankruptcies are expected to surge. Thanks to our liquidity criteria, we’ve been fortunate enough thus far to avoid any defaults in our bond portfolio.
Raising liquidity during a crisis can be prohibitive and costly, which eventually impacts a company’s stock valuation and price. So not only is a strong balance sheet important in bond analysis, but it is also a key investment tenet on the equity side
at NGA. This period confirmed its virtue as, generally speaking, those companies with strong balance sheets performed better than those more highly leveraged.
Automation of production lines has been a developing trend, and we believe the coronavirus will accelerate it. Simply put, robots are immune to viruses. Those manufacturers that had already transitioned were certainly in much better shape. Those that had business continuity issues as a result of outbreaks or social-distancing requirements will likely look to pursue higher factory automation and robot implementation to not only reduce human vulnerability to future pandemics but also reap the traditional benefit of streamlined operations.
Virtual interactions and robotics depend on technology such as network equipment, cell phone towers, fiber optics, the cloud, semiconductors, etc. When all is said and done, we believe the biggest winners from the pandemic’s disruption will be the collective technology and automation segment. There is a reason why technology is typically our largest portfolio sector exposure.
We’ve mentioned themes – past, present, and future – that we are thinking about as we attempt to minimize risks while providing real, long-term capital appreciation of your assets. It’s not easy to balance the risk and rewards, but we believe we do our best work – both on the investment and planning front – in volatile periods like the last few months. We’ve enjoyed working with you in the past, we are working hard for you in this difficult moment, and we are excited to continue working together in the future.