FWR talks to a range of North American wealth management firms about how they think clients should deploy their assets to deal with the aftermath of the pandemic, a possible second spike in the virus, and policy counter-measures.

As high and ultra-high net worth clients begin to review their portfolios in the wake of the shattering impact of the coronavirus crisis, wealth managers face perhaps the most daunting challenge of their professional lives: How to allocate assets in the best way?

While uncertainty is undoubtedly the overriding theme of the coming months and perhaps years, top chief investment officers and market strategists are arriving at a consensus of key sectors investors should consider - and avoid - when rebalancing their portfolios, an exclusive Family Wealth Report survey reveals. 

The disruption of the global supply chain is a trend investors must take into account, asset managers agree.

“The COVID-19 pandemic, arriving on the back of US-China trade tensions, has clearly demonstrated the vulnerability of global supply chains,” UBS Global Wealth Management chief investment officer, Mark Haefele, wrote in a recent note to clients. “Following the crisis, companies and governments will likely seek to diversify their supply chains and bring them closer to home.”

UBS identifies warehouse automation and online shopping, both of which should see significant structural growth as a result of the localized supply chain, as “long-term beneficiaries” of the trend.

The Colony Group is advising investors to “focus more on domestic demand” than global trade, Jason Blackwell, chief investment strategist for Colony, said.

“We’re looking at strategies that will help the Chinese middle-class consumer paint the inside of their home rather than ones that focus on selling a television made in China to an American consumer,” Blackwell says. “The number one pizza delivery company in India deserves attention, as do online education services in China.”

The global supply chain was already under threat before the pandemic, Mark McCarron, chief investment officer for Wescott Financial Advisory Group, noted.

“Protectionism and trade wars have slowed global trade and the coronavirus crisis will probably extend it,” McCarron said. “When it comes to asset allocation, we’re looking at which companies and sectors are most exposed to that trend. Auto companies and manufacturing, for example, are certainly under significant pressure.”
 

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The need for large-cap stocks
Investment professionals also agree that large cap tech stocks - exemplified by companies such as Microsoft, Apple, Facebook and Google’s parent company Alphabet - have become a safe harbor for investors looking to take advantage of an equity risk premium.

Large cap domestic growth stocks, led by the so-called FAANG stocks (adding Amazon and Netflix to those mentioned above) now make up approximately 40 per cent of Frost Investment Advisors model portfolio, Alan Adelman, chairman of the firm’s equity strategy committee, said.

After reviewing its asset allocation strategy in the wake of the pandemic, Frost, a wholly-owned subsidiary of Frost Bank in San Antonio, with over $5 billion in AuM, exited its emerging market and small cap holdings, maintained a small exposure to mid-cap stock and focused on what Adelman calls “traditional core stocks” such as Microsoft.

“We wanted good core exposure to industry leaders and companies that are well-positioned as vital for consumer staples,” he said.

Large cap-tech stocks are poised to be leaders in the post-pandemic economy, according to Tony Roth, chief investment officer for Wilmington Trust. Large cap healthcare stocks and top-tier companies that sell consumer staples are also expected to perform well, says Roth. Investors seeking to take advantage of this kind of equity exposure should consider active managers, he added.

“Active managers are the way to go right now,” Roth said. “They are more apt to add value in volatile times.”

And investors shouldn’t limit themselves to just the biggest and best known large cap tech stocks, says Wescott’s McCarron.

“We’re shifting up in market cap,” McCarron said. Buying large companies like Proctor & Gamble and Johnson & Johnson that are considered “defensive staples” has been part of that re-allocation, he added.

 

Wescott is also looking at large companies that are well run but “a level below” the FAANG stocks, such as Adobe Systems, Comcast and Verizon, according to McCarron. “We think companies that can be resilient today and stronger tomorrow are part of a good investment strategy,” he said.

The fixed income challenge
As interest rates drop to historic lows, the fixed income portion of a client’s portfolio is becoming particularly challenging in the wake of the pandemic.

“Investors looking for higher yields in the near or mid-tem will be disappointed,” Patrick Leary, chief market strategist for Incapital, a fixed-income wholesaler to advisory firms, said. “A 10-year Treasury below 1.0 per cent will push investors into riskier assets. And if the yield is too good to be true, it probably is.”

Investment grade corporate bonds, despite yielding just slight over 2 per cent for a five-year note, still offer an attractive alternative to government bonds, Leary said. High quality companies like Apple - not known for issuing debt - are now taking advantage of cheap credit, he noted.

“Investors have plenty of options,” Leary said. “But there are caveats - they should diversify among sectors, stick with the cream of the crop and companies that have strong balance sheets. And beware of businesses that will be negatively impacted by the crisis, such as energy companies.”

Despite the news that the Federal Reserve Bank of New York will start buying exchange traded funds, Leary said that high and ultra-high net worth investors are better off with individual bonds.

“ETFs can be good for small IRA accounts, but more sophisticated investors should take advantage of a pure fixed income return,” he said. “ETFs are more susceptible to underlying risk. They are subject to perpetual securitization and they never mature.”

Frost is also overweighting investment grade credit, according to Adelman.

“More high quality companies are issuing debt,” he said. “We’re looking at intermediate fixed income securities to reduce equity exposure and take risk off the table.”

So-called “catastrophe bonds,” a high-yield debt instrument designed to raise money for companies in the insurance industry in the event of a natural disaster, are another fixed-income option, said Colony’s Blackwell.

“There is market risk and investors need to do due diligence, but it’s a different way to get income into the portfolio,” he said.
 

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What to avoid
What should investors avoid when reallocating assets this year? Airlines and cruise ship lines top the list, say investment professionals. 

Likewise, brick-and-mortar retail chains and companies associated with sharing vacation homes or office space are “not ideally positioned” for the post-COVID-19 economy, said Laura Kane, head of thematic investing in the Americas for UBS Global Wealth Management.

Wescott is steering clear of sectors highly exposed to “economic sensitivity” such as energy, commodities, materials and industrials, said McCarron. And Wilmington Trust is staying away from utilities and companies in the financial sector while at the same time is “considering gold for the first time.”

Real estate as an asset class drew a mixed reaction.
Wilmington Trust is avoiding malls, new residential housing and stores. But Roth expects industrial warehouses and Class A office buildings to “do very well.”

Colony’s Blackwell also expects Class A properties “to stay steady,” noting trends toward online shopping were already in place. “Businesses are still going to want a shiny new office where they can bring clients even if there’s less people working there,” he said.

But other real estate investments will depend on the ability of managers to “improve and reposition properties,” Blackwell added.

The market-economy disconnect
The seeming disconnect between the markets and the economy for most of the past month has compounded the asset allocation challenge facing wealth managers.

Noting the stock market’s performance, in spite of the fact that 36.5 million jobs have been lost in the US in the past two months, “You’d think we were living in the Twilight Zone,” Incapital’s Leary said.

 

However, ‘Don’t Fight the Fed’ is one of the time test-rested maxims followed by stock market professionals, he said. 

Indeed, the Federal Reserve Board’s massive injection of liquidity into the credit system as well as record low interest rates help account for what Leary calls “equities asset inflation.”

But a buoyant market “is pricing in a lot of things going right, including quick introductions of a vaccine, treatments and people getting back to work,” according to Blackwell. “Could that happen in two years? Yes. But in the next three months there’s a lot of room for disappointment.”

Roth agreed.

A frothy market “is priced for perfection,” he said, while disappointments in needed government cash transfers or vaccine trials can easily lead to “more downside.”
Wealth managers and their clients need to recall the fundamentals, Roth said.

“Follow your plan, don’t make major changes, rebalance at the appropriate time and don’t jump in and out of the markets.”

No one predicted that the US stock market would rebound so quickly after reaching its low on March 23, Roth said. And the markets may well hit new lows again, he warns.

If that should happen, Roth said, investors need to call on whatever reserves of discipline they have and remind themselves that it’s better to ride the market down and then back up “than to get out and never get back in.”