This virus is a known unknown for the markets

The new Coronavirus COVID-19 continues to spread and be a mystery, but homo economicus has already found the defences and the way (perhaps) to monetise it.

The impact of production and distribution slowdowns, although not yet predictable, certainly will occur: and in fact the major retailers (Apple, Adidas, Puma) have already put their hands forward: better, they suggested, limiting expectations on the results of management of the 'year.

If, however, we look at past health crises, the emergency declaration of the World Health Organization (which took place on 30 January) is usually the turning point and the time to adopt, in terms of investment choices, a constructive approach. Historically, free cash flow yield is the investment factor that performs best after international health crises and is what our Simplify 02 fund will adopt in the coming months.

Let's see. The market trend in recent days seems to discount the announcement of yet another monetary support to the system threatened by the tight cordon around China. The Beijing government is likely to launch a broad program of interventions to support the economy, from monetary support (which favours gold prices) to the nationalization of the industries most affected. The immediate consequence would be a new rally, not only of the stock market but a bit of all the markets. Certainly also that of gold.

In the United States, the massive monetary interventions of the Federal Reserve ended a month and a half ago and the markets, especially the bond market, proceed on autopilot. In the short term, the corporate bond market is among the least attractive given that most issues have negative real returns. To use the cash (and not suffer the effects of negative rates), Simplify 02 only considers Treasuries (or Bund) as temporary risk hedges. The high yield component deserves separate reasoning, straddling the bond and equity markets.

The fund's asset allocation is positioned in the least volatile part of the efficiency curve by limiting exposure to equity and bond markets with an annual volatility target of 2.56. Both asset classes today have inefficiencies and uncertainty factors. The alternatives? Two: move along the efficient frontier towards more illiquid and long-term investments, as some university endowments or sovereign funds are doing; or, combine the asset classes so that the risk components neutralize (at least in part) each other without prejudice to consistency with the objectives of low volatility and return.

Simplify 02 has chosen the second option alongside strategic and tactical investments in equities, investments in gold and Treasury (the latter actively traded on a par with equities).

The current breakdown of the portfolio is as follows:

• Europe Equity net: 5.678%;

• US Equity net: 6.985%;

• Gold: 14.71%;

• Treasury: 4.80%.

An example of equity market neutral strategy followed by Simplify 02 is long US ESG / short S & P500 which since the beginning of the year has yielded about 1% with practically zero equity exposure. (please find a chart of the trade here)

Another low volatility strategy is the opportunistic purchase, driven by specific events, of high yield bonds. This, perhaps, is today the least desired asset class, but if carefully selected and purchased after a significant event (such a cash capital increase), there are concrete possibilities to obtain an extra absolute return. The security is then sold before the value realigns to the yield curve.

We believe in this strategy (which has proven effective in numerous cases) but we do not consider the high yield environment to be a good investment for the long term. The weight of its component in the Simplify 02 portfolio is highly variable: at the moment it is 18.91%.

The performance of the high yield bond strategic factor (observable, as an index, on Bloomberg, HY_ARB Index), has contributed significantly to our performance in recent months and we are considering building a dedicated fund. If so, we will only distribute it in reverse inquiry. For related information, contact our administrator (Finexis SA) or consult our website


Best regards

Simplify Partners Management Team

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