The onset of the world’s first truly global pandemic in over 100 years and the unprecedented lockdown rules that effectively shut down economies caused markets to sell off dramatically in March before rallying almost as hard in April.
For investors, though, there are a number of lessons to be learned from from these recent market events, according to MSCI Research managing director Dimitris Melas.
Global investing provided risk diversification opportunities
The first lesson for investors is focused on the risk diversification benefits of global investing. As well as being more resilient in the longer term, companies with international revenues and assets have been among those that have performed best since the onset of the pandemic.
According to MSCI Research, companies deriving at least a quarter of their revenues from abroad outperformed those with revenues below the 25 per cent threshold.
Internationally and domestically oriented companies, relative to MSCI ACWI
Source: MSCI Research
“For investors, global portfolios were less exposed to regional or sectoral troughs in performance, as the crisis spread to different regions at different times and with varying intensity,” said Melas.
“At the corporate level, companies with assets, revenues, supply chains and operations across multiple locations may have been more resilient to local disruption in economic and business activity."
He added: “Following this crisis, risk diversification, in addition to revenue growth and cost reduction, may become an increasingly important driver of business and investment decisions.”
Managing factors became more critical than picking stocks
The second lesson revolves around factor investing and how awareness of them became more important during the volatile market conditions as the pandemic spread.
“Covid-19 unleashed a surge of volatility, manifested in a torrent of sharp movements across global financial markets,” said Melas.
He said cross-sectional volatility rose more sharply than stock-specific volatility, meaning that factor awareness became “more critical than picking the right stocks”.
“Avoiding airlines, for example, when the crisis struck was far more important than choosing between British Airways and American Airlines,” he explained.
Rising volatility offered active management opportunities
However, greater volatility in markets also gave rise to opportunities for active managers, although its less clear that fund managers took advantage of these opportunities.
“Markets have not been indiscriminate during the crisis,” said Melas. “We witnessed large variations in performance across asset classes, market segments, regions, countries, sectors, industries, strategies, themes and individual securities.
“Sharp drawdowns in economically sensitive factors accompanied by small drops or even rallies in safe-haven assets, far from reflecting market panic, demonstrated a rational and discriminating reaction by investors. These declines provided opportunities for adding value and generating returns through active portfolio management.”
However, MSCI found that just 26 per cent of funds from a sample of 1,600 global, international and emerging market equity funds were able to beat their benchmark during the first quarter with little evidence suggest that high conviction strategies fared better.
“On a more positive note, we found some evidence of persistence in performance: 67 per cent of top-quartile funds – based on their previous five-year active return – outperformed their benchmarks in Q1 2020,” the company noted.
“Funds that had been successful in the five years to 31 December 2019, were also more successful in navigating the volatile market environment of the Covid-19 crisis and capitalising on the opportunities offered by it.”
Sustainable investing helped to mitigate drawdowns
The ongoing integration use of ESG factors in investment analysis and portfolio management seems to have also helped protect portfolios during the crisis, said the MSCI Research managing director.
Relative performance of selected MSCI indexes with ESG and climate objectives
Source: MSCI Research
“We previously identified ESG characteristics as a potential way to mitigate systematic and idiosyncratic risk,” he explained. “The Covid-19 pandemic provided the first real test of this hypothesis. Companies with strong ESG characteristics suffered smaller drawdowns in relative terms.”
Indexed investing enabled active portfolio management
Lastly, Melas noted that the large dispersion in performance across different segments and strategies during the sell-off allowed investors to seek out returns and risk diversification opportunities. Many of these strategies could be accessed via exchange-traded funds (ETFs) and other index-trackers, he noted.
Indeed, such products remained resilient during the crisis and continued to provide liquidity and flexibility to investors, despite concerns about the huge sums that have been invested in such products before the crisis.
Many ETFs saw substantial flows and elevated trading during the sell-off, noted MSCI, yet they continued to track their underlying indexes closely despite greater volatility.
“Index-based strategies played a critical role in facilitating price discovery, promoting market efficiency and providing flexible tools that enabled active portfolio management in a rapidly changing market environment,” said Melas.
A final lesson that everybody should note, according to Melas, is that while the crisis may accelerate the de-globalisation trend and the unwinding of almost 30 years of multilateralism and free trade since the collapse of the Soviet Union, there are still many benefits of international partners working together.
“A global crisis is not necessarily a crisis of globalisation,” he said. “In fact, it could strengthen the case for globalisation.
“Pandemics, like climate change, affect all countries and can be addressed more effectively through international cooperation. You cannot keep a deadly virus out of a country any more than you can prevent climate change from crossing national borders.”
Melas concluded: “An important lesson from this crisis for investors and policymakers is that, far from shutting borders, drawing bridges and erecting barriers, international cooperation, trade and investment, sharing of knowledge, information and resources, combined with effective governance and prompt action, are the key to maintaining economic prosperity and mitigating the social, economic and financial impact of a future global crisis.”