The coronavirus/oil double whammy: reassessing your defence | BetaShares

The coronavirus/oil double whammy: reassessing your defence

BY Adam O'Connor | 10 March 2020
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The Coronavirus/oil double whammy: reassessing your defence - defensive allocations

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Fears around the impact of the coronavirus have been compounded by oil’s woes, causing the biggest falls on Wall Street since the GFC. On Monday, the S&P 500 index fell 7.6%, triggering the first automatic halt in trading in more than two decades, and even though Tuesday was an ‘up day’ it seems as though volatility may continue for some time.

In the face of the coronavirus/oil double whammy, many investors will likely be looking to the defensive allocations of their portfolios.

What are the key risks?

While the coronavirus outbreak may have stabilised in China, the ongoing concern is its potential spread to other major economies. The key risk is that authorities will be forced to implement containment measures that restrict economic activity and have a significant negative effect on consumer spending and business activity. On Monday, the Italian government placed the entire country under lock-down.

The turmoil in the oil market has exacerbated this already volatile environment. With news that Saudi Arabia has launched a price war against Russia, the price of crude oil plunged by 26% on Monday. Energy stocks, both in Australia and overseas, have been pummelled over the last two days. While cheap oil benefits users, a collapse in the oil price savages both energy companies and countries that rely on revenue from petroleum. There is also the potential for widespread defaults among high-cost U.S. shale producers, which now poses a significant risk to U.S. high-yield debt markets.

How have defensive assets performed over the last two weeks?

In the search for yield, many investors have taken on increased risk by investing in higher-yield, sub-investment grade bonds.

The problem is that in widespread sharemarket sell-offs, high-yield bonds historically have behaved like equities as investors flock to higher-quality assets like government bonds. As a result, high-yield bonds tend to provide little in the way of defensive benefits and portfolio diversification.

Demonstrating this, there have been large falls in some domestic high-yield funds which have large exposures to U.S. high-yield securities. In contrast, government and investment-grade corporate bonds have remained relatively stable.

AGVT’s Index (Australian government bonds) +0.48%
Ausbond Government Index (Australian government bonds) +0.58%
AusBond Composite Index (Australian government and corporate bonds) +0.41%
CRED’s Index (Australian investment grade, fixed rate corporate bonds) -1.16%
S&P/ASX 200 Index (Australian equities) -12.91%

Source: Bloomberg. Performance from 25 February to 10 March 2020. Index performance does not include impact of ETP’s fees and costs. Past performance of index is not indicative of future performance of index or ETP. You cannot invest directly in an index.

What are some potential options?

While the appropriate action depends on an investor’s particular financial circumstances, investment goals and tolerance for risk, investors wanting to prepare their portfolios for a long period of virus-related uncertainty could consider the following options to help with diversification.

Option 1: Investment grade bonds over sub-investment grade bonds

  • Higher-quality bonds should show a significantly lower correlation to equities, and also be much less sensitive to concerns around the risks of default, than high-yield bonds with equivalent maturities.
  • As a result, fixed-rate investment-grade bonds should still be considered defensive, unlike high-yield bonds.
  • The worse things get, the greater the expected relative out-performance of investment-grade bonds vs high-yield.

Implementation

BetaShares Australian Investment Grade Corporate Bond ETF (ASX: CRED) – CRED provides exposure to a portfolio of up to 35 investment-grade, fixed-rate Australian corporate bonds.

BetaShares Legg Mason Australian Bond Fund (managed fund) (ASX: BNDS) – BNDS invests in an actively managed, diversified portfolio of Australian bonds, including investment grade bonds, semi-government, government and supra-national bonds.

 

Option 2: High-quality, long-maturity government bonds

  • During risk-off episodes, investors typically trade away risky, uncertain equity cash flows for known, relatively low-risk government bond cash flows.
  • Historically, the longer the maturity of a government bond exposure, the greater the negative correlation to equities has been during risk-off events.
  • Long-maturity government bonds also tend to benefit in an environment of falling interest rates.
  • Government bonds with longer maturities are considered as potentially one of the best portfolio diversifiers.

Implementation

BetaShares Australian Government Bond ETF (ASX: AGVT) – AGVT provides exposure to a portfolio of high-quality, income-producing AUD-denominated bonds issued by Australian federal and state governments, supranationals and sovereign agencies.

 

Option 3: Gold

  • Gold has a long history of being sought out as a ‘safe haven’ asset during periods of equity market volatility.
  • Gold serves as a store of value. You can print more banknotes – but you can’t print more gold. This makes gold resistant to the action of central banks, and to the devaluation of currencies.

Implementation:

BetaShares Gold Bullion ETF – Currency Hedged (ASX: QAU)  – Physically backed by gold bullion, QAU is the only $A-hedged gold ETF available in the Australian market – i.e. exposure to USD gold prices. Reflecting uncertainty in markets, over the 12 months to 6 March 2020, QAU returned 28.4% compared to 4.3% for the S&P/ASX 200 Index1.


1. Past performance is not indicative of future performance.  Investment value can go down as well as up. An investment in the Fund should only be considered as a component of a broader portfolio.

3 Comments

  1. COURTOT YANNICK  |  March 11, 2020

    Hello Adam. Option 4 could be buy the dip , but which sectors
    could recouver first in the few months / year to come ?.

    Thank you

    Yannick

    1. Gavin Montgomery  |  March 13, 2020

      Hi Yannick,

      ‘Buy the dip’ is certainly a valid option. And one deserving of a separate conversation in its own right.

      Given our broad range of funds we chose to focus this piece of commentary just on the defensive allocation of portfolios. I would say watch this space for some further commentary on the upside risks to markets and some relevant options for ‘buying the dip.’ In the meantime, you can see our range of equities ETFs under ‘Our Funds’ on the website – which we have divided by asset class, including Australian Shares, International Shares, Global Sectors and Geared. You can also filter that page by ‘investment goal’ and select capital appreciation.

      Kind regards,
      Adam O’Connor

  2. Ozjon  |  March 12, 2020

    Curious as to why you didn’t suggest my, Motley Fool’s and Warren Buffett’s strategy for dealing with market dips !
    …. Don’t Sell !
    ,.. Buy more Good Growth Stocks ( or ETFs like NDQ, ASIA, GGUS, etc) at a discount !

    Hard to believe that Microsoft, Apple, etc are REALLY worth 20% less than they were a month ago.

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