Staying afloat during Covid-19: why income is not the only answer for investors
Other assets can help to withstand volatility, such as gold, cash and government bonds
It is no surprise that Covid-19 is continuing to impact a host of sectors worldwide, with the situation in the Mena region further exacerbated by lower oil prices. In times like these, an active investment approach becomes even more critical, as fund managers can evaluate what opportunities are likely to arise from the volatility and adjust portfolios accordingly.
Although regular income may seem attractive in the short term, in the long term it can prove costly if not reinvested, thanks to the power of compounding.
Sandeep Singh, Franklin Templeton
What can be underappreciated is that during sharp market corrections some asset classes tend to have lesser drawdowns than others. ‘Risk off’ assets like gold, cash and government bonds are well-known for this, however, one that is not as common and has a compelling risk/return track record during volatility is ‘liquid alternative mutual funds.’ Liquid alternatives are different from traditional hedge funds because they are priced daily – thus offering daily liquidity – are fully transparent and typically have lower costs. In general, liquid alternatives have a low correlation to traditional investment solutions and are a good diversification tool, which can make them an attractive addition to any portfolio.
Another asset class that has potential to fare better during turbulent times, specifically in this region, is GCC bonds. Even during periods of volatility, it has typically remained resilient and offered strong, risk-adjusted returns (how much return an investment makes relative to the amount of risk it has).
This is attributed to the fact that GCC bonds are generally US dollar denominated and exhibit a low correlation to oil price performance. So, while many investors assume the region, and consequently the asset class, is susceptible to headline risk and oil price volatility, the opposite is true – even in today’s global health pandemic. In early March, GCC bonds sold off only 60 per cent of the sell-off of emerging market debt and roughly 50 per cent of high-yield debt.
Despite the range of assets that can withstand volatility, we continue to see investors based in the region prefer products distributing regular income. This is taking into consideration that the aforementioned assets, when included as part of a well-diversified portfolio, generally offer better risk-adjusted returns. The biggest reason we are seeing this trend towards regular income strategies is because investors want a steady cash flow, even if they are young, employed and haven’t been hit with a crisis that requires a sudden capital injection.
Although it makes sense for these investments to be in higher demand among retirees who need money to pay for living expenses, they are popular among investors from different age groups and with varying financial goals.
There are several other reasons investors like regular income. Some use these strategies to enhance yields on current investments. There are also those who are still feeling the "hangover effect" from the 2008 financial crisis, and in today’s Covid-19 pandemic want cash handy. Furthermore, some investors may have been hit with an unforeseen event like a job loss, which is more common today, so are in search of income.
Although regular income may seem attractive in the short term, in the long term it can prove costly if not reinvested, thanks to the power of compounding. This can be illustrated with an old tale about a king and farmer who played a game of chess and the farmer won. In return for winning, the farmer, an excellent mathematician, asked the king to give him one grain of rice for the first chessboard square and double the number of grains for each square following, covering the whole board of 64 squares (so one, then two, four, eight and so on).
The king thought this would be a small amount overall so agreed, but when he reached the last square, he owed more than 210 billion tons of rice. This example shows how making small, regular investments can produce results in the future.
As we try to look past Covid-19, it is important to remember that markets have historically rebounded from viral outbreaks – including SARS, Swine Flu, Ebola and Zika. During periods of great uncertainty, like today, we encourage investors to try to avoid making decisions based on emotions. They can do so by staying focused on their investment goals, making regular investments and diversifying their portfolios. This too shall pass, and investors who manage to stay the course could reap benefits.
Sandeep Singh is the regional head of Central and Eastern Europe, Middle East and Africa and Head of Islamic business at Franklin Templeton
Updated: May 25, 2020 12:57 PM