News and Notes from USAG – Part I: How COVID-19 and the response has impacted investment portfolios

It’s a new world, with a lot more uncertainty still to come. As I write this on Saturday morning (4/4/20), the US healthcare system is looking awfully vulnerable, with signs out of New York City and horrifying stories there of what may (may!) lie ahead for the rest of the country. We are seeing improved testing for COVID-19 in some parts of the country, but in others, there absolutely is a lot of work to be done. And that does not include the ongoing shortage of essential medical equipment, both PPE (which to me has always been an accounting term – that seems to be forever changed in my mind) and ventilators, not to mention all of the ancillary gear and equipment that will be needed in the weeks and months ahead.

Reading reports of GE stepping up to make ventilators, something that is hardly the equivalent of building cars, with supply-chain problems of parts needed to actually *build* the ventilators this morning; reports of states and governments fighting over equitable supply of gear so desperately needed by our amazing front-line workers in medicine and public services; reports of accelerating daily deaths in the US from COVID-19. All of this is to say, these are highly uncertain times for our own personal healthcare and safety.

As the pandemic tears through the globe, economic activity has essentially ground to a halt for many (not all) sectors. The US service sector, really the main driver of US economic growth in the last few years, has essentially been shuttered, as non-essential businesses have been ordered to close by many states across the country, including here in Massachusetts. US 1st Quarter GDP numbers, which were on track for ~ 3% of annual growth, are going to take a hit; and 2nd Quarter estimates (which are really just ballpark guesses at this point as economists don’t yet have much data to back this up) are projecting 20-30% (annualized) contraction figures.1

Investors have priced in, it appears, the short-term economic shock in terms of what we know *now* about global efforts to contain the virus. However, even though volatility subsided a bit last week, we are still in historically high levels, and more volatility ahead is almost certain, particularly as new stories about the continued spread of the virus arise, the death toll mounts, and more investors hit the panic button.

On US Advisory Group’s Portfolios:

Fortunately (if I can use that word) for us, at US Advisory Group, we are generally long-term investors, and I’d like to remind folks of how we approach our portfolio construction. Many factors are weighed to help formulate clients’ risk profiles/tolerances, but the fundamental philosophy of how we construct our portfolios is consistent. We use cash and bonds (primarily) to generate short-term stability and income for our clients who are drawing income. And we use stocks to realize long-term growth. So while a 45-year-old will typically have greater exposure to stock market volatility in *their* portfolio because their need for income is a longer-way off, and a 75-year-old will have much less stock exposure and instead own more conservative, income-generating tools in *their* portfolio, as long as our clients’ investment philosophies are well-designed and aligned, our clients’ portfolios are built to ride through this spike in volatility.

We have been talking with our clients for really the last 2 years about the need to be cautious as we seek growth in the equity/stock markets. As such, we have built the equity/stock sleeve of our portfolios around a typically value-based core of equities, and we favor dividend-paying and dividend-growth stocks. Despite the massive volatility, we feel that our core equity positions have held up quite well, and we expect them to recover in due course.

Our bond/fixed-income portfolios have also stood up quite well in the last few weeks. About 3 weeks ago, as hedge funds dumped Treasuries into the market (positions they had been short in up until recently), we saw highly atypical volatility in the more conservative end of bond markets, but, as expected, the bond market has returned to much more normal levels of volatility. Our core strategy in bonds the last few years, as interest rates have remained at historically-low levels, has been to own shorter-duration, higher-grade positions. This has proven to be an excellent strategy in light of recent activity. 

And the other add-on components of our
portfolios have been quite responsive as well.

  • First of all, we tend to keep a sleeve of cash in our client portfolios, especially for folks taking income, and so while markets are getting knocked around, we don’t have to sell as many equity positions to maintain clients’ current income.
  • Secondly, we typically have smaller allocations to “other” equity sectors – many times that will include (relatively small) developed-world international equities and a sleeve of “small cap” companies. We use these as hedges against US economic shocks and to help when global markets are roiling, respectively. In this “black swan” type of event that we are in currently, equity markets globally are getting hit, so there is not a huge benefit *at the moment* in owning positions like these vs. US large caps. However, as economies and markets recover, we absolutely want to be globally diversified, as other countries/economies/regions may make quicker recoveries than others (i.e. the US).
  • Third, we typically have a slice of real estate in our portfolios. Real Estate as an asset class is often considered a third “alternative” to owning stocks/equities and bonds/fixed income. As we have often discussed before, real estate can (not always) act with less correlation to volatility in equity markets, and it also has a bond-like component via dividend distributions. So while investors panic and sell off equities, real estate is often impacted to a lesser extent. And as bond yields fall when interest rates are cut (as the Fed has done in recent weeks), real estate dividends often look more attractive to fixed income investors. We typically have a mix of illiquid real estate positions (reducing volatility) and some liquid positions – we have been heavy on the illiquid side recently as we have been very aware of low interest rates and narrow spreads on cap rates – with the economic crisis we are in, there are very likely to be huge opportunities here on the recovery that we are looking at very closely.

A final comment on our portfolio construction strategy – while we are generally not the world’s biggest annuity fans, we have always said that they can and do serve a purpose in some clients’ portfolios. There are myriad different types of annuities, they can all work in different ways, but the main purpose is (typically) to add an additional layer of protection to client portfolios by offloading risk onto the annuity/insurance company. We oftentimes give up some flexibility or liquidity or growth potential in that trade, but periods like we are experiencing today, with huge volatility and market turmoil, bear out the practicality of these tools in the right situations.

So where do we go from here? Obviously, there is still a lot up in the air.

First of all, we have endeavored at US Advisory Group to keep the lines of communication WIDE open with our clients. We don’t want to inundate your inboxes, but we want to make sure each of you has a clear idea of the efforts we are making to keep the boat as steady as possible in these conditions. The entire team is here at your disposal essentially 24/7 to answer any questions you have; to talk about or consider individual strategies or just to reassure your mind – we know how scary a time this is, particularly being locked up at home with the inescapable flow of news flashing through our screens. 

Second, as we have communicated previously, we are hard at work here making sure that when markets recover, (and they will recover!) that we are as well-positioned as possible to take advantage. We have always favored a blend of active- and passive-managers in our portfolios. We will likely be adding a bit more to the active- side of the world as markets settle and begin the recovery – we will be updating clients portfolio-by-portfolio as those changes are made.

Next, many folks have asked if YOU should be doing anything differently. We don’t want to make short-term decisions now that could negatively impact the long-term, particularly in times of such heightened uncertainty, particularly in this case of what the long-term economic impact of COVID-19 will be. And so long term investors should stay invested for the long term. That said, all clients should make sure to review their end of their overall liquidity situation.

If you feel like you may have a need for income greater than what we have currently planned, please call the office, and we can re-evaluate your strategy. For clients with cash in your portfolios and who need cash, that’s where it will come from. If additional cash is needed, we would look at selling pieces of your fixed-income portfolio, and then the equity positions last, as we want to give those as much time as possible to recover. We genuinely feel like we have a very firm grasp on our clients’ financial needs, but we are also increasingly aware that given what appear to be lengthening economic impacts, we want to make sure we are closely in the loop on how all of our clients are faring on the financial side (and obviously on the personal side as well). Our conversations with clients in the last few weeks have given us little reason to doubt our overall plans, but if anyone has any uncertainty, we absolutely want to hear from you! 

Along those lines, for folks who are drawing income above-and-beyond what is needed to maintain comfortable cash flow or above-and-beyond what is needed for DISCRETIONARY goals (i.e. travel/vacations/entertainment (I know, no one’s going anywhere anyway right now!)), we should talk about possibly reducing income for the short term as markets settle. We are NOT recommending income cuts from our portfolios at present – as we have emphasized, our portfolios are BUILT to ride through this crazy time – but for folks who were planning to take out $10k for a trip to Ireland, for example, let’s possibly reconsider that for the short time being.

Separately, Required Minimum Distributions are no longer required for 2020. If you have previously scheduled your RMD for 2020 and have not taken yet, and do not NEED to take it, please do not hesitate to give us a call and we can discuss deferring that. 

Other important things we are doing: As previously mentioned, re-balancing portfolios is an important part of managing assets through market upheavals – we are constantly evaluating this aspect. Roth conversions *may* make sense in some cases while market values are down, we are evaluating these on a client-by-client basis and will be in touch individually as those opportunities present themselves. Additionally, we are posting this update and future updates on our firm’s blog at usadvisory.com as well as on our facebook, so please be sure to like and share any posts you find relevant there. 

Continue reading Part II.

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