6min read

Abhimanyu Chatterjee, Dynamic Planner’s Chief Investment Strategist, discusses the hot topic of inflation amid increasing concerns it could soon rapidly rise. How has it been viewed over time? What are arguments both for and against?

Abhimanyu then analyses what could happen next before outlining four extreme inflation scenarios Dynamic Planner has run to robustly stress test its Asset Risk Model. Finally, he considers cash flow planning and inflation’s potentially acute impact here now for financial planners

Everyone worries about rising prices, especially savers. This general increase (or decrease) in prices of goods and services in an economy is referred to as inflation (or deflation). Margaret Thatcher referred to it as ‘the robber of those who have saved’, while the high priest of the ‘Free Market Economy’, Milton Freidman, called it ‘taxation without legislation’.

The general rise in the price level in an economy results in a sustained drop in the purchasing power of money, as each unit of currency buys fewer goods and services. It reflects a loss in the real value of the medium of exchange.

The opposite scenario, deflation, is characterized by a sustained decrease in prices in the economy.

Market participants are firmly of the opinion that low, positive and stable inflation is generally good for the economy as inflation causes reconfiguration of labour markets through increasing wages and lower unemployment. Excessive inflation or deflation is generally the cause for concern, often caused by step changes in monetary policy.

Inflation: Arguments for and against

It is said that if there are 10 economists in a room, there are 11 opinions. A debate on the causes of inflation results in 20 opinions in the same room.

One often cited reason for inflation is an increase in money supply – both steady or sudden as we have observed during the continuing Covid crisis or during the financial crisis of 2008.

Central banks in the developed world this year have expanded their balance sheets to previously unseen levels to stimulate their economies. Governments have moved beyond monetary policy to fiscal measures, given diminishing marginal returns of monetary policies. In addition, central banks are prepared to move away from their mandates of inflation stability for a period of time to jump-start economies.

As can be seen in Figure 1 above, while CPI inflation has dropped significantly due to the slowdown in demand, the expectations of inflation has picked up from previous levels. On the other hand, the case for disinflation is gaining traction.

At Dynamic Planner, we feel that, rather than being a financial crisis, as seen in the past, this is a social crisis – a crisis in which consumers are voluntarily choosing to socially distance themselves and postpone consumption, due to uncertainties surrounding health and employment. In addition, there is a sizeable output gap across the global economy, indicating spare capacity.

In China, the current output gap is around 7.5%, an historical high, as it is in the US (8%), which stands at the same levels of the Great Depression. In addition, there is a school of thought that the link between money supply and inflation has broken down – a case in point being the large stimulus measures implemented during the Financial Crisis 2008 did not result in runaway inflation as was expected then.

Further, given the nature of the current pandemic, it is obvious there will be sectors which will be worse off than others and hamstrung in their efforts to grow. Previous bouts of quantitative easing and other fiscal measures failed to increase inflation materially, with divergence being even more stark and asset prices rising and the bulk of the economy facing disinflationary forces.

Inflation scenarios: Stress testing the Dynamic Planner asset allocations

In stress testing our allocations, we consider four specific scenarios:

  1. Reflation: In this first scenario, monetary and fiscal policy proves to be successful and stimulus brings the economy closer to its pre-Covid long-term trend growth. Nominal rates remain relatively stable, inflation picks up to levels slightly above 2% and the US dollar strengthens. This is good news for equity markets in general. With real rates and risk premia decreasing further, they could gain around 16%.
  2. Deflation: A grimmer scenario where dis-inflationary trends get the upper hand despite central banks across developed markets keeping yields of all maturities close to zero. With economic growth impaired and increased uncertainty, this is bad news for equity markets, which could lose around 23% in this scenario, with growth stocks underperforming the market.
  3. Inflation overheating: In this scenario, inflation picks up slightly more than planned, which leads to disrupted economic growth and increases in nominal rates as the US Fed reacts to rising inflation. Equities benefit moderately from decreasing real rates with growth stocks benefiting more from declining real rates.
  4. Stagflation: This final test is a more extreme version of the previous one, with inflation going up even more. However, this scenario assumes developed market economies are impacted more severely than other regions, as a result of more aggressive fiscal and monetary stimulus. Although real rates decline, growth disruption and uncertainty take the upper hand, pushing equities into slightly negative territory and resulting in a positive bond-equity correlation.

In assessing these scenarios, we have set out the major risk factors to perform in Figure 2 below:

Based on the above scenarios above, we calculate the performance of the allocations for the different Dynamic Planner Risk Profiles.

As can be seen from the graphs in Figure 3 below, the deflationary scenario is the worst one for our allocations, which is understandable, as in this scenario all growth assets underperform immensely.

On the other hand, modest inflation increases or a re-emergence of the economy from the stress and uncertainty of the pandemic would be extremely beneficial for the allocations. In the stagflationary scenario, allocations for the more conservative risk profiles would be safe while the more aggressive allocations with higher equity allocations would suffer mild negative performances.

As fiscal and monetary policies expand to allow governments to deal with the fall out of the pandemic, market participants have started engaging in conversations regarding the possibilities of inflation. This analysis is meant to add structure around conversations for our clients, who use our allocations as a guide to making allocation decisions.

Cash flow planning with confidence

To navigate scenarios as mentioned, our clients, at the coalface of financial planning, need to create a long-term cash flow plan for their clients.

If the plan uses inflation and growth assumptions which are reasonable and based on objective data, a financial planner can engage more effectively with their client and create a quality and understandable plan.

Dynamic Planner forecasts real returns – i.e. net of inflation – across its system, in the risk-reward trade-off shown for risk profiling, in investment portfolio reviews and in cash flow planning.

The forecast is generated by a Monte Carlo scenario engine that generates thousands of possible real returns. As the returns are real to begin with, the various possibilities for inflation at different times are already factored in. It is therefore inappropriate to guess and factor in other numbers for inflation and apply them to the forecast.

With current events set to make inflation more confusing and volatile, clients will need your advice and explanation even more. It is therefore even more important that growth assumptions used are risk-based, real, reasonable and based on objective data. We conduct extreme stress testing like this, so that you can have confidence in ours and plan confidently with your client.

Read about new Dynamic Planner Cash flow planning

The Investment Committee reviewed the performance of the benchmark asset allocations and noted their great resilience in weathering the extreme market turmoil post the Covid outbreak, with all staying within, or very close to, their expected annual Value at Risk (VAR) limits.

The benefits of portfolio diversification provided by Dynamic Planner’s Asset Risk Model can be illustrated by the level of annual drawdown the benchmarks have experienced over these unprecedented times.

The one-year returns are compared to their respective expected VAR, within a 95% confidence limit, as represented by the horizontal line in the charts below. The benchmarks are calculated by MSCI [Morgan Stanley Capital International] and include quarterly rebalancing.

Navigating cross currents

  1. Uncertainty over the extent of lockdown measures and the nature of the eventual economic recovery prevails. In the absence of a vaccine, bolstering consumer confidence remains the priority for the post-lockdown world, but rising fears of the growing second wave of infections is beginning to see the re-imposition of stricter social distancing measures.With sentiment so fragile, any prolonged economic weakness could lead to increasing defaults from over-indebted corporates and the vicious cycle of increasing unemployment. However, there is an important distinction between the ‘run on the banks’ witnessed in 2008, to the ‘run to the banks’ to borrow this time round, as banks have significantly shored up their balance sheets.All eyes will be focused on how and when furlough measures will be adapted and tapered, as they must eventually have to be, given the eyewatering levels of debt / GDP that many economies are now having to grapple with.
  1. Interest rates are at rock bottom and if they remain ‘lower for longer’ or even ‘lower forever’ is an open question.Whether this macro demand-led shock leads to a long-term macro ‘regime change’, with the possibility of negative interest rates and deflation across developed economies, cannot be ruled out at this stage. However, low interest rates and excessive monetary stimulus must normalize at some point.In the case of the UK, the ballooning debt overhang, coupled with potential supply side inflation as a result of a no-deal Brexit and further weakening of the pound, could plausibly result in interest rate increases becoming necessary.
  1. From a valuation perspective, global bonds appear extremely overvalued after the extent of central bank intervention, with around 20% of issuance now in negative yield territory in nominal terms.Given the recent strong market bounce, global equity valuations also appear stretched and considerable uncertainty prevails around economic forecasts and corporate profitability. Existing business models are coming under increased scrutiny, with the market already signalling the potential winners (e.g. the tech and healthcare sectors) and the losers (such as retail, transport and energy).
  1. Given this unprecedented backdrop, ‘volatility of volatility’ will be an ongoing major concern for investors and can be expected to manifest itself in periods of heightened spikes.

Dynamic Planner Annual Asset Allocation Review – Key themes

During the annual review process, the Investment Committee agreed that the long-term strategic themes of building out further global diversification and a reduction from bonds into equities should gradually continue. The revised allocations – that went live in Dynamic Planner on 24 September 2020 – include:

  1. Further reduction in UK equities and an increase to US equities
  2. Reduced allocation into Sterling Corporate Bonds being exchanged for an increase in Global Investment Grade Bonds
  3. Recentralisation within expected risk boundaries being required. This involved marginal changes for the equity exposures being applied to the higher risk benchmark allocations

What’s the latest market and economic analysis? Read ‘Depression to euphoria’, by Abhi Chatterjee, Dynamic Planner Chief Investment Strategist

We are in the middle of a synchronized downturn. Analysis of the quarter or quarter change in GDP globally and in the US makes grim reading – worse than anything observed in the past.

Partially, this is due to the global reduction in activity through lockdown restrictions to mobility. Yet, if equities were to be considered as a barometer for future global activity, this would appear to be the shortest recession in history.

We can spotlight the performance of the S&P 500 Index. From being down approximately 30%, the market crossed its previous peak of 3389 on 18 August 2020. And with the backdrop of increasing infections globally, especially in the United States, and the upcoming presidential election in November. Analysis shows a real disconnect between the financial assets and the real-world economy. In addition, the stocks on NASDAQ, primarily small tech companies, have recovered an eye-watering 78%, after a drop of 28%.

In response to the Covid-19 crisis, central governments across the globe have unveiled massive fiscal and stimulus packages to help sustain their economies, especially from threats to the labour market.

The scale of stimulus has even dwarfed those created during the global financial crisis 2008. The stimulus packages in United States amount to approximately 13% of GDP, with the UK at 5% of GDP. The comparable figures in 2008 were 5.9% and 1.5% respectively.

A consistent concern expressed at this tidal flow of liquidity being provided is what happens in the wash. The bull run in equities and the compression of yields of corporate bonds is often attributed to the stimulus provided by central banks along with lower interest rates, which can be considered as a form of stimulus as well. Post the implementation of the emergency measures since March 2020, we see the same pattern re-occur, albeit on steroids.

The market participants have been especially selective. Consider [above] a chart of the 10 largest companies in the world and their market capitalisation as well as the change quarter on quarter. It is incredible to note that capitalisation of the top 10 companies is the highest that it has ever been and up almost 30% from the previous quarter. While it is understandable that after a severe shock to markets, there is generally a rebound in the valuations, in 2020 even compared to previous crises, the change in value appears egregious.

In addition, we can look at the composition of these 10 companies [above]. Since the time we have collected this data, which starts from Q2 2006, the companies have been composed of seven GICS sectors whereas as of Q2 2020, it composed of four sectors.

Out of the 10 companies, seven of them are technology enabled and include the likes of Facebook, Apple, Google, Microsoft and Amazon. The non-tech companies include Berkshire Hathaway, Visa and Johnson & Johnson.

Like any crisis, the Covid-19 pandemic has been a catalyst for change, being referred to even as the ‘Great Acceleration’. While it is immediate in some areas, as in the change in consumer behaviour and adoption of e-commerce, in others we may not see the impact in a few years.

What all economic participants realise and agree on is that there is no going back to pre-Covid in terms of business models, as well as consumer preferences and behaviours. What we do expect to see are the following:

  1. Shift to value and essentials. This, being a social crisis, affects the real economy more than previous crises. Uncertainty about prospects and health concerns, has shifted focus to being mindful of spending and researching brand and product choices before buying
  2. Increased and persistent utilisation of digital channels. Becoming a requirement due to restricted mobility, this is a trend which appears to have been adopted the most by consumers. The growth has been across the board for all kinds of products and across all age groups.
  3. Decreasing brand loyalty. Due to supply chain disruptions for certain products and brands, consumers could not find their preferred products at their preferred retailer. This has had an impact on brand loyalty through brand switches, with value, availability and quality being the main drivers.
  4. A home-based economy. Consumers have increased their consumption of in-home offerings across all sectors. This is not linked to easing of government restrictions, rather than waiting on guidance from medical authorities.

Given these changes, it is only logical and natural that companies which have already adopted such consumer preferences, within their business processes or have changed rapidly to do so, have benefited.

But, as we saw in the lead up to the dot-com bubble in the 1990s – a period of massive growth in the use and adoption of the internet – any company which purports to do business online or related to e-commerce, cloud computing or disruptive growth has seen huge uptake, resulting in near-egregious valuations.

So, when we look at headlines blaring about the peaks made by S&P 500, one tends to forget that it’s mainly the tech-driven companies which have been bought – even over bought maybe. As with any such exuberance with the advent of the new, there is always a dampener as business models get fixed into place. Winners and losers among the adopters will arise, leading to a shake-up in markets.

Looking forward, we expect to see some volatility coming through in markets, as investors rationalise and reassess. But this only serves to separate the wheat from the chaff – leading to the re-establishment of new order.

As investors, we need to be wary and congnizant of these changes and constantly re-assess the relative risks that arise. It is tempting and often simpler to go with the flow. But not jumping the FOMO bandwagon could possibly be the way forward.

Learn more about Dynamic Planner’s benchmark asset allocation.

Looking back over the first half of the year, January seems to be a completely different era. In between, an unprecedented health crisis has uprooted medical care, financial markets and the prospects for the global economy. In spite of the sharp rebound in markets, allocators are still reeling from the vehemence of the sell-off.

As economic numbers are now released, the severity of the downturn becomes slowly apparent, with further contractions expected for the rest of the year. Repeat lockdowns and voluntary social distancing, as well as uncertainty around re-opening, continues to negatively impact economic activity. Consumer confidence remains the priority for the post-lockdown world.

While unemployment has been kept in check with financial support from governments, as these policies stand to run off, as surely they will, uncertainty about jobs could delay consumption, leading to further decline in activity and a vicious cycle of defaults and further unemployment. These could possibly freeze up financial conditions, exposing vulnerabilities of already over-indebted households and corporates.

Though we have witnessed a sharp rebound in risk assets, we do wonder whether the market is pricing in a quicker recovery than what the ground reality is telling us. Analysis shows that the S&P 500 Index and Consumer Confidence has historically trended together, but recently there has been a decoupling, with a parting of ways for the two.

S&P 500 / Consumer confidence

As we look forward, what started feeling like a macro shock has slowly started to morph into a macro regime change. Government borrowing across the developed economies have reached eye watering levels, the proceeds being used to buying back government and for the first time, corporate debt, both investment grade and high yield.

Corporates themselves are going through an identity crisis, with business models and profitability coming under pressure from changing consumer preferences. Usage in public transport and workplaces have been way below baseline, with residential numbers higher than baseline in spite of re-opening. Thus, sectors like retail, energy and commercial property come under pressure.

Google UK mobility data

Even as business activity restarts, heightened health and safety concerns will continue to slow progress. It is likely that the recession we are in will be long and drawn out. Thus, with this context in mind, valuations of equities and fixed income, especially credit, appear to be stretched.

If markets were being irrational before the crisis, it looks to continue being irrational for some time to come. In fact, John Maynard Keynes’ pithy comment comes immediately to mind, ‘The markets can remain irrational longer than you can remain solvent’. In times like these, portfolio risk comes to the fore for our allocations and client solutions.

To achieve investment goals and meet the needs of clients, we need to stay invested, as the alternative would be inherently unproductive. Without risk, we would not have a return. Thus, we need to focus on putting together a portfolio of ‘desirable’ risks – risks which can be mitigated if the need arises, like the risk arising out of investments like equities and fixed income.

Risks like liquidity are the undesirable ones as there is nothing one can do if no one wants to buy illiquid holdings. Focusing on risk in this way helps us achieve our objectives, while keeping our powder dry to take opportunities as and when they arise, which they certainly will.

Clients in decumulation – What is the best defence against market volatility?

[vc_row type=”in_container” full_screen_row_position=”middle” column_margin=”default” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” scene_position=”center” text_color=”dark” text_align=”left” row_border_radius=”none” row_border_radius_applies=”bg” overlay_strength=”0.3″ gradient_direction=”left_to_right” shape_divider_position=”bottom” bg_image_animation=”none”][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/1″ tablet_width_inherit=”default” tablet_text_alignment=”default” phone_text_alignment=”default” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][vc_column_text]As we try and shed our feelings of embattlement, with lockdown finally easing across most of the UK, the macro environment is radically different from the one which faced us when we entered lockdown in March, writes Abhi Chatterjee, Dynamic Planner Chief Investment Strategist.

Today, we are faced with an economy which is re-starting – with all its screeches and grinding gears – helped by the lubrication and deluge of ‘helicopter’ money, be it in terms of cheques to individuals or furlough schemes and loans to corporations. Here in the UK, this has been called the ‘Bounce Back Loan Scheme’ or BBLS.

The current situation has both similarities and dissimilarities with the last global financial crisis of 2008. Like then, governments and central banks across the planet reacted promptly in a coordinated manner to bolster the economy and put forward the balance sheets of central banks.

The difference now in 2020 is that 12 years ago it was just one sector – the financial sector – which had to be bailed out. This time it is all sectors across the board, apart from a few, that need bailing out.

Economics 101 says that with an increase in money supply to a system, ceteris paribus, all things being equal, inflation should increase.

Post-2008, when the money taps were opened by the central banks, threats of inflation came to the forefront. However, while we waited and waited, the inflation that was predicted never arrived. The debate regarding the why and wherefores rages on. Now, as was then, once the fiscal stimulus has been delivered, inflation has started to dominate discussions once again.

But is there only one possibility, just inflation, or does its alter-ego, deflation, get to dominate media headlines this time around?

Anyone can see the reasons for inflation, given the enormous largesse being doled out. However, inflation, which has recently been below the central bank targets, fell further during the lockdown. Even with the fiscal stimulus provided by central banks, the barriers posed by social distancing to shopping and increased precautionary saving has led to falling prices – evident from the falls in inflation in the developed economies.

Along with lower oil prices, lack of demand may quite possibly lead to companies discounting prices to reduce inventory and generate cash for their running costs. While this may not be the case for essential goods, the prospect of cheaper prices of non-essential purchases may prevent immediate expenditure by consumers.

Also, during this period, numerous companies have been looking into methods of increasing productivity and growth through the implementation of technology and digital transformation. If this continues apace, there is a possibility that growth in our economies takes on a different dimension and requires us to rethink our theories.

To quote from American-based Professor Yossi Sheffi’s Anna Karenina principle – every economic crisis comes with its own ‘roster of causes, cascade of effects and its own litany of misery’.[/vc_column_text][/vc_column][/vc_row][vc_row type=”full_width_background” full_screen_row_position=”middle” column_margin=”default” equal_height=”yes” content_placement=”middle” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” bg_color=”#ffffff” scene_position=”center” top_padding=”80″ bottom_padding=”80″ text_color=”dark” text_align=”left” row_border_radius=”none” row_border_radius_applies=”bg” overlay_strength=”0.3″ gradient_direction=”left_to_right” shape_divider_position=”bottom” bg_image_animation=”none” shape_type=””][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/2″ tablet_width_inherit=”default” tablet_text_alignment=”center” phone_text_alignment=”center” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][vc_custom_heading text=”Want to see what Dynamic Planner can do for you?” font_container=”tag:h2|font_size:36|text_align:left|color:%23000000|line_height:44px” use_theme_fonts=”yes”][vc_column_text css=”.vc_custom_1534103308164{margin-top: 15px !important;}”]Schedule a free no-obligation demo with a business consultant and experience the full functionality of Dynamic Planner.[/vc_column_text][/vc_column][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/2″ tablet_width_inherit=”default” tablet_text_alignment=”center” phone_text_alignment=”center” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][vc_row_inner column_margin=”default” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” text_align=”right”][vc_column_inner column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/1″ tablet_width_inherit=”default” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][nectar_btn size=”large” button_style=”regular” button_color_2=”Accent-Color” icon_family=”default_arrow” url=”https://www.dynamicplanner.com/demo/” text=”Request Demo” margin_top=”20″][/vc_column_inner][/vc_row_inner][/vc_column][/vc_row]

By Abhi Chatterjee, Chief Investment Strategist

In the last six weeks, I have seen more from my home office desk than all the time I have previously spent in my career on trading desks. To recap, what have we witnessed?

Given stringent social distancing policies have been largely in place, a sharp decline in economic activity has already occurred, as shown by PMI numbers plummeting to unforeseen lows.

It is expected that we will see a deep recession in the Western, as well as Emerging economies. The question now though still remains, ‘How long will the recession last and what will the long-term impacts of the coronavirus pandemic be?’

Answers are currently only speculation, as details of how and when lockdown measures precisely will be eased are only just emerging – and, of course, there is also the real threat and future concern that there will be a second, significant spike of infections.

Extrapolation of data from past recessions are unlikely to help. All we know is that pent-up domestic demand should come back online, once social distancing measures gradually begin to be rolled back, but economic growth may still be sluggish due to an equally gradual growth in international trade and investment.

Following the pandemic’s outbreak, central banks globally have unleashed a flood of fiscal policies to help the private sector and the cornerstone of all developed economies. In a concerted action across the board, central banks in developed countries have assured individuals as well as corporations that no measure is big enough for them to use in these times.

Central bank rates are at all-time lows; asset purchase programmes are worth billions and involve buying up of below investment grade debt and asset-backed securities; and governments effectively are providing loan guarantees to mortgages providers, banks and the like.

It appears Western governments have opened their balance sheets for households and the private sector, in order to stave off bankruptcies and large-scale lay-offs. Credit is the fuel which businesses run on and the availability of credit will determine which parts of the economic anatomy remain unaffected by all this.

However, credit perpetuates on the optimism of growth – the promise of an increase in activity resulting in repayment. Without growth, be it sustained or otherwise, we face a self-reinforcing cycle of diminished confidence, bankruptcies and lay-offs. Thus, the over-leveraged world, which gorged itself on debt in a low interest environment, looks on with mounting concern and interest – if you pardon the pun.

The policies enacted now by public institutions face the ultimate dilemma and balancing act: the creeping devastation of a stagnant economy or a terrible human cost.

Abhi Chatterjee is Chief Investment Strategist at Dynamic Planner and helps lead its expert, in-house team of analysts, who each quarter risk profile the 1,400+ investments currently available in Dynamic Planner – to research and recommend to clients of financial advice firms.

Speak with a consultant to find out how Dynamic Planner fund research can help your firm

By Abhi Chatterjee, Chief Investment Strategist

The ‘Corona Crash’

The Covid-19 outbreak triggered a geo-economic panic, resulting in an unprecedented spike in global equity market volatility, with severe declines exceeding 20% and extreme daily swings on a scale comparable to the financial crash of 2008.

Thus, we dramatically marked the end of a remarkably resilient equity bull market, that had begun back in March 2009. The moves largely occurred in late-February and March as numerous countries went into lockdown in response to the pandemic, bringing economic activity to a virtual standstill globally.

Meanwhile, government bond yields and prices were incredibly volatile. Yields first hit extreme lows on heightened fear, but then rose, as panicked investors sold off liquid assets indiscriminately, in order to raise cash. High yield credit was hardest hit given this dramatic spike in risk aversion, with the rout most evident in sectors perceived as most vulnerable, such as those related to travel and retail, as well as energy, given the price of Brent crude plummeted to its lowest level since 2003.

In emerging markets, the heaviest falls were suffered by local currency denominated bonds. There were double-digit declines, in some cases of around 20%, linked to issuance in currencies perceived as more sensitive to the economic growth shutdown, falling oil prices, and those with more market liquidity.

Maintaining essential checks and balances

The committee reviewed the performance of the current benchmark asset allocations, which have proven so resilient during this and other periods of extreme market volatility, with none breaching their defined, 95% value at risk limits over the quarter.

The above charts show the rolling, 12-month index returns for risk profiles 4, 5, 6 and 7 updated each month.
The horizontal lines are the respective, 95% value at risk limits for each.

The key role of the Investment Committee [IC] is to ensure that prudent checks and balances are in place, so the integrity of Dynamic Planner’s forward-looking asset and risk model is maintained. During the meeting, the IC carefully considered what could be learned from recent events and whether its current process in forecasting asset class growth and volatility remained appropriate if we are witnessing a significant macro-economic regime change in the making.

Given these extreme market swings and the current uncertainty, as to how long the global lockdown measures will remain in place, after much discussion, the IC agreed that now was not the time to make any changes to its long-term growth forecasts or strategic asset allocation benchmarks. There are just too many unknowns presently over the scale of the economic impact and recovery trajectory, the downstream implications of the huge fiscal and monetary stimulus measures on growth, inflation and interest rates and the likelihood of a viable vaccine becoming widely available.

The current process used for volatility forecasting involves detailed analysis and interpretation of data trends from both a long and short-term perspective. This requires striking a careful balance with the data inputs to the model. The danger of giving too much credence to short-term noise is the potential for overshooting of data in times of extreme market anxiety, potentially leading to significant misalignment in the forecasts generated.

Conversely, the process needs to be sufficiently sensitive to detect emerging changes in how asset classes are expected to behave and their impact on future volatility and correlations over the longer term. For this particular quarter, given the extent of recent extreme data outliers, the IC agreed that their use would be inappropriate on this occasion. Therefore, the longer term data trends for volatility and correlations were used for the Q2 2020 volatility and correlation assumption setting. The data derived from the shorter term modelling techniques were not included.

The IC also noted that post-Brexit negotiations between the UK and the EU were still ongoing, but no significant breakthroughs before the end of the December transition period that could have any bearing on the model assumptions have yet to be announced.

Summary of Investment Committee Q2 2020 decisions:


You should not rely on this information in making an investment decision and it does not constitute a recommendation or advice in the selection of a specific investment or class of investments.

Between 16-19 March, financial markets, as we had known them, were a thing of the past.

If one took data from the S&P 500 since 1927 and the FTSE 100 from 1984, and calculated the largest single day losses, two days in March 2020 make the top 10 largest ever single day losses – only showcasing how shocking falls have been.

The speed and severity of losses have been unprecedented. Markets dropped approximately 25% in only four days. Investors who had experienced and lived through 2008 and the global financial crash shook their heads in disbelief. Never had we seen moves like this before.

One often hears market participants talk about ‘time spent in the market’ or remaining invested, in short. Never has that been more relevant than now – because, once the severity of the shock of the coronavirus crisis is hopefully behind us, one can expect growth rates to be high.



Read about one adviser’s experience of the COVID 19 crisis here

Investment in Physical Property has been a cornerstone for multi-asset solutions. However, investing in Physical Property through investments funds, which provide daily liquidity can cause liquidity mismatches.

While the impact of this liquidity mismatch is not observable under normal market conditions, periodically, when these inherently illiquid investments are subject to large amounts of redemption, the impact manifests itself in valuations as well as the ability to monetise the value in the holdings. Thus, when a financial planner advises a client to set aside money to spend in the future, the client is clearly expecting that when the time comes, they will be able to spend it. No financial planner needs to be told the client reaction to, ‘I am sorry, but you cannot have your money’.

With this in mind, we looked to reduce the liquidity impact of Physical Property in our investment portfolios.

We recognize that Physical Property provides diversification to a multi-asset portfolio, but we feel that the diversification provided is due to the inherent nature of the investment, primarily the lack of valid mark-to-market valuations, which characterize a freely traded instrument like a stock or bond, wherein the risk arising out of liquidity are built, into the price.

As we recognize that yields from Property investments (as well as infrastructure and other long-term investments) can be quite high, we felt to reduce the impact of liquidity in the solutions through a daily priced mechanism would be more suitable in the long run. With this in mind, we feel that access to the high longevity assets through Investment Trusts would be more suitable.

The use of REITS in multi-asset solutions allow us to access the cash flows of illiquid assets without subjecting the portfolio to any of the liquidity risk of the underlying assets. It has been a much favoured way of investing in Property across the globe.

In our experience, more and more asset managers, who provide multi-asset solutions and do not have access to in-house property funds, are resorting to the use of REITs as a means to access Property investments. However, REITS tend to be much more correlated with equities rather than the underlying Property holdings. This is because these investments are quoted on an exchange and allow an investor to easily rotate out of this asset allocation as and when he or she chooses. During periods of market instability, REITs tend to exhibit volatility characteristics and correlations akin to equities. However, we feel that it is a small price to pay for the liquidity and ease of investment operability that it brings.

At Dynamic Planner, when considering the asset allocation changes, we felt that using a mix of REITs and Physical Property was an appropriate way to invest in the Property asset class. To cater for the increased volatility and correlation that the mix provided, we decided to cut down our holdings in the Property bucket from 8% to 5%. This, we felt, was the best way to balance the reduced risk from liquidity against the increased risk of correlation in the portfolio.

Find out more about Dynamic Planner’s asset allocation and Asset and Risk Modelling.