Risk Management: Navigating through an unpredictable, high-impact event
This health crisis has highlighted the fragile environment in which markets have been operating for several years. The years of exceptional monetary policies have had the effect of crushing volatility, and of orienting investors towards risky assets. Consequently, as soon as this violent deflationary shock created by the fall in demand and aggravated by the oil shock took place, the equities & some segments of fixed income markets collapsed indiscriminately.
To tackle this abrupt surge in financial and economic risk, central banks and governments finally announced sweeping measures that gave markets a breathing spell allowing the market to rally off the lows.
But now we think that the markets have to digest the harm this will do to the economy/company earnings and importantly the duration of that negative hit -which might be longer than what is priced into the market..
What have we done to manage the risk of Carmignac Patrimoine since the beginning of the crisis?
When the wave of the virus has started to shift from the East to the West, we decided to substantially reduce our risks as we didn’t want to deal with uncertainties. We decided to reduce our exposure to peripheral bonds and to Emerging market debt, to cut drastically our net equity exposure and finally to increase our cash holdings.
Since then the portfolio construction remains very cautious, with some selected performance drivers in credit and equity counterbalanced by low risks on sovereign bonds, a gold exposure and a low risk profile on currency. In addition, to navigate through volatile markets, our hedging policies in all asset classes remain in place, while we actively and tactically manage our exposure through equity exposure, and modified duration.
Being risk manager is also seizing opportunities when we see a positive asymmetry: the massive fiscal and monetary announcements have led to a reduction of the solvency risk for the best issuers in the credit space. Therefore, Rose is selectively buying back corporate bonds of companies with robust balance sheets that we believe should be able to recover well from today’s very bombed-out levels. However, as these rebuilt medium-term convictions might still suffer from short term volatility, Rose and David have decided to hedge part of the Beta of this credit book by calibrating some short on equity indexes which in our opinion offers better liquidity and it reflects our tactical preference for the credit compared to equities at current levels.
Beyond risk management, long-term convictions
We maintain an equity portfolio focused on high visibility / non-cyclical companies and we steer clear of those with the heaviest debt loads, as the interruption of business activity could put some of them under a serious cash strain.
In term of geography, we tend to have a slight relative preference for China compared to other regions. The economic activity is picking up as the lockdown is ending gradually. And even if the country will need to cope with the sharp fall in external demand, currently the balance of payment is improving supported by lower oil and commo products as well as the shutdown of global tourism. We are positioned on domestically oriented names, benefiting from policy support and long term trends of Chinese New Economy Sectors (eCommerce, healthcare, data centers).
In terms of sectors, we seek exposure to disruptive thematics, linked to the ongoing shift in habits, and some of them accelerated by lockdowns. For example, as people are stuck at home, we see an increase in the development of e-commerce, which could become further anchored in consumer habits. Precautionary measures insisting on avoiding physical contact have also led to the increase use of digital payment, supporting the development of fintech. Stay-at-home dynamics have also increased the use of streaming and video games, which in turn is increasing demand for software, cloud and semiconductors.
On the fixed income side, we manage actively the overall modified duration of the Fund which is currently at low level.
The sovereign market has acted in a very extreme way, with volatility levels not even reached in 2008. The Fed’s bazooka is unprecedented and should drive yields across the US curve lower. While the ECB’s actions support peripheral debt, we don’t think they offer a favorable risk/reward yet as both debt is expected to grow and growth is expected to be particularly weak, therefore we have benefited from higher liquidity provided by central bank actions to reduce further our exposure to eurozone periphery.
On credit as mentioned above, we are selectively buying back some names with robust balance sheets.
On currency, the serious pressure on US yields convinced the Fed to pump unprecedented amounts of liquidity into the market. Now that the Fed’s interventions – announced as being unlimited – are seen to have stemmed the dollar liquidity strain, the appreciation of the greenback should slow. We have therefore kept the euro – the reference currency for the fund – as our primary currency exposure in order to limit exchange-rate risk in an abidingly uncertain environment.
Carmignac Patrimoine & Carmignac Portfolio Patrimoine
Main risks of the Fund
EQUITY: The Fund may be affected by stock price variations, the scale of which is dependent on external factors, stock trading volumes or market capitalization.
INTEREST RATE: Interest rate risk results in a decline in the net asset value in the event of changes in interest rates.
CREDIT: Credit risk is the risk that the issuer may default.
CURRENCY: Currency risk is linked to exposure to a currency other than the Fund’s valuation currency, either through direct investment or the use of forward financial instruments.
The Fund presents a risk of loss of capital.