Quarterly update from M&G Prudential regarding PruFund (Q4 2020)
- A good quarter for most asset classes within
- PruFund portfolios
Risk assets rise strongly on positivity of vaccine news and the expectation that economies return back to normal some time in 2021
- Pfizer/BioNTech achieve the milestone of getting their vaccine approved by the FDA first
- Biden wins the US Presidential election convincingly with Trump disputing the result in many states Democrat “clean sweep” of the Senate and House of Representatives has implications for future sector leadership as well as fiscal spending expectations
- United Kingdom officially leaves the European Union after 47 years of membership
- Developed world governments agree to more COVID-19 fiscal packages after second wave of infections in many parts of the world
- Despite positive news there are still plenty of unknowns
We hope you enjoy this update. It is longer than usual but 2020 was quite year and a lot happened in the final quarter which we want to cover off. The usual market update will be provided, and we also want to give an insight in to some of the themes that will play out over the coming months and maybe years.
After such a challenging year, the final quarter of 2020 saw markets finish strongly off the back of several pieces of good news. Clearly, the positive news on COVID vaccines dominated the headlines and investors thoughts, such that markets have remained stable (so far) despite new variants and a significant increase in infections in many countries.
All the positive news was good for PruFunds which saw another raft of upward prices movements in November.
Several themes have been prevalent since March. Pleasingly, most concluded by the year end:
COVID 19 Vaccine
The main story over the quarter, as the combined effort of governments around the world, along with international pharmaceuticals, galvanised the fastest vaccine research, development, and approval in history. Pfizer/BioNTech released their trial results on 8th November, showing better than anticipated efficacy levels of 95%. Other companies shortly followed suit with trial results demonstrating strong efficacies such as Moderna and AstraZeneca. However, the UK had the coup of approving the vaccine for use before its American cousins in December and rolled out the first global inoculation of the drug on 11th December, when grandmother Margaret Keenan became the first post-approval recipient of the vaccine.
Second Wave Lockdowns
With winter here indoor gatherings increased. This combined with various mutations being discovered around the world led to the COVID-19 case count starting its second exponential rise. At the time it was felt that nations had experience under their belt and were more adept at dampening the mortality rate through therapeutics and instigating local lockdown measures, although the mortality rate has started to creep up. There is still much uncertainty around when there will be a return to ‘normality’ but it seems that markets are generally looking through this short-term bad news with the vaccine roll-out providing the light at the end of the tunnel.
The US election
Coming into 2020, President Trump appeared to have a clear lead in the polls but this popularity proved short lived. His relaxed attitude to cases and death counts and the collapse of the US economy led to a fall in his polling numbers. The Democrat challenger Joe Biden was thought to be a safer pair of hands, with decades of experience in politics, a more centrist outlook, and a determination to deal with the virus head on. Even though the election was a landslide for Biden, the divisive campaigning, Trump’s refusal to concede and his claims of election fraud did create uncertainty in markets. Once official, Biden’s victory was well received. Our sense is that he will be much more environmentally friendly, the rhetoric towards trading partners will certainly change, although tensions with China will remain ever present. The team believe his fiscal packages and overall policy agenda will be good for growth although may come with increased taxes.
Monetary and fiscal accommodation
The ECB launched a fresh wave of stimulus in December, including €500bn more in bond purchases – expanding the total size of the programme to €1.85 trillion – while reinvesting proceeds until at least the end of 2023 and extending the amount of low-cost funding available to banks. As well as bond purchases, accommodative Fed policy in the US maintained plans to keep rates near zero until the economy reaches full employment and inflation is on track meet and exceeds its 2% target with their new average inflation mandate. Policymakers currently expect rates to remain at zero through to 2023. In November, the Bank of England unanimously voted to increase its bond purchase programme to £150bn from £80bn, which exceeded market expectations. Negative interest rates remain a possibility in the UK, with BoE Governor Andrew Bailey unwilling to rule out their use or give the market a strong steer as to his preference.
However, the most impactful government response came from fiscal policy, where the damage of curtailing economic activity was managed by multi trillion-dollar loan packages and transfer payments globally.
The free trade agreement signed with the EU is by no means a bureaucracy-free agreement as significant border checks and form filling will be required to do business with the continent, at an estimated cost of £7bn p.a. to UK plc. The overall cost and benefits of leaving the single market will only become clear over the next several years. Teething problems are no doubt ahead, but market participants breathed a sigh of relief, as a long running issue was effectively closed.
As highlighted, a large rally in risk assets occurred during the quarter, where in the UK the sectors related to a reopening of the economy led the market with steep rises in their share prices. Airlines, energy companies, and banks were a few of the sectors that outperformed with names like IAG, Royal Dutch Shell and Santander rising by 73%*, 34%* and 68%* respectively over the quarter.
From a UK investors’ perspective, the years’ return for Asia, Japan and Emerging Markets came almost entirely from the fourth quarter with Asia ex-Japan and Emerging Markets up 13.5%*, Japan up 7.5%*.
This was positive for PruFunds, all of which hold globally diversified portfolios of equities, although we should acknowledge that the largest equity position (the UK) finished the year still well in negative territory despite the strong finish.
While positive COVID-19 vaccine news and a decisive outcome in the US elections drove strong gains across global equity and corporate bond markets, returns for core government bonds were more muted as investors rotated away from traditional safe havens.
In contrast, UK corporate bonds delivered solid returns in the quarter, as improved risk appetite and hopes of a gradual reopening of the economy led to a further tightening in credit spreads. The standout performers in this space were lower-rated assets, such as UK high yield bonds.
International corporate bond markets ended the year well with riskier high yield and emerging bond bonds performing strongly, with the more positive macro backdrop coupled with easy monetary policy. Euro and US high yield bond spreads tightened by over 100 basis points and emerging market bonds by 79 basis points in the final quarter, with corporate bond spreads having widened and tightened back close to pre-pandemic levels.
For some time, our philosophy has been to favour corporate bonds within portfolios, so this has been more good news and a good end to a year, which saw that dramatic sell off in corporate bonds markets in late February and March.
UK Commercial property delivered positive returns in the fourth quarter, as rental income offset moderating capital declines. A flight to quality triggered by the pandemic has seen investors become more negative on non-prime assets with leasing and vacancy risk, in favour of core assets with secure income profiles and strong covenants. The surge in online retailing has intensified the contrasting fortunes of industrials and retail. Industrials (which includes distribution centres) were the standout performer, achieving both rental growth and further yield tightening. On the other hand, retail continues to struggle, although supermarkets and retail warehouses are showing greater resilience. While the decline of retail is structural in nature and predates the pandemic, negative trends have been accelerated by the events of 2020. Meanwhile, good quality centrally located offices in London and core regional markets are holding up, but secondary stock is coming under greater pressure, as investors pause to assess the future of the sector.
2020 will be remembered as a tough year for commercial property, one of the key asset classes in PruFund. The tide appears to have turned and those portfolios that have been positioned to hold high quality assets across all sectors should see the pick-up in sentiment continue in 2021, particularly when restrictions are lifted. While more challenges lie ahead we firmly believe the potential yield of property is still worth paying for.
Questions for 2021
Despite a positive quarter, the broader economic and market outlook is not without risk. There are several areas that we are mindful of.
How will the pandemic evolve?
Whilst vaccine distribution is well underway any indication of dangerous new strains could derail markets and governments still must try and manage the removal of restrictions and fiscal stimulus at the most appropriate time, but this will obviously be different for different countries.
How quickly will spending patterns revert to normal?
The consumer is a key component of the global economy. The various lockdowns have reduced spending and increased savings which of course is a big drag on economic activity. Looking forward will a lot of savings be spent when economic freedom returns or are people likely to be more prudent?
President Joe Biden is certainly less outspoken than his predecessor, but we expect ‘America First’ polices to be a continued source of friction. So, the rhetoric may tone down, but the tensions will continue, and this could create nervousness in markets.
Will ESG change the market?
This is a broad question for now and the future. For example, what is the future of companies heavily reliant on fossil fuels?
Within UK financial services we have already seen a surge of interest in ESG and indeed within Prudential and T&IO a huge amount of work was carried out in 2020 to create an Asset Owner Policy and to more formally embed ESG considerations across all areas of investment activity within PruFund portfolios.
Productivity to rise?
Remote working has been a step-change for so many companies and some have adapted better than others. Shifting consumer behaviour has rewired parts of the economy, changing not only how people work but, in some instances, what sector they work in.
From a top down perspective, will this lead to a spurt of productivity growth or potentially mask the fact an increasing number of companies are struggling?
We don’t currently see upward pressure on interest rates in the short to medium-term and the messages from central banks supports this. There is an enormous debt overhang which is going to need to be repaid at some stage, although our strategists believe this debt is still currently serviceable.
We have also said for some time that structural factors like globalisation, demographics and technological change have helped keep a lid on inflation and hence the need for central banks to raise interest rates.
2020 proved that global events and capital markets can make a mockery of forecasts, however having assessed all the facts, our base case is that we are through the trough of this self-enforced recession and look upwards to a broad global recovery, although it will still be well into 2022 until we see a return to pre-pandemic levels of economic activity.
The reason for the cautious optimism is that the trade deal was signed between the UK and EU. President Biden has control of the Senate and the House of Representatives. Vaccines against COVID-19 have begun to roll out. Central bank monetary support, either directly or through forward guidance, aligned with government pandemic support packages, is aimed to maintain confidence. We also recently saw additional US fiscal stimulus agreed recently.
Cautious optimism is the byword here, as we see the symptoms of excessive monetary and fiscal policy in the inflation outlook a potentially longer-term issue. Monetary authorities are determined to keep borrowing costs low, as a result there is an implicit cap to yields which should keep sentiment positive.
*Data source Bloomberg