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Taking Stock Spring 2019

Why defence makes sense

18 November 2019
Authors: John StopfordHead of Multi-Asset Income, Jason Borbora-SheenPortfolio Manager, Multi-Asset

Reading time: 5 minutes

At a glance:

  • The worst drawdowns typically happen in recessions. Investors have experienced even worse drawdowns in this bull market than previous ones.
  • This is particularly harmful to investors with nearer-term horizons, who are relying on assets they have built up previously. For example, retirees who need attractive, sustainable income in their later years could be hard hit – especially now they're living longer.
  • Why is this happening now? We believe a changing market structure caused by slower economic growth, central bank intervention and more passive investors in the market could be the culprit.

Recession obsession

Many commentators are talking about an increasing risk of recession. Our own recession probability models agree, with Figure 1 showing more than a 50% chance of a recession happening in the next two years. As recessions are typically associated with much worse market returns, this increasing risk has led investors to look for defensive strategies that emphasise drawdown management.

We believe that even outside of periods of increased recession risk, defence makes good sense for investors – particularly for those whose investment horizon is limited.

Figure 1: US recessions and Investec two year ahead recession probability model

Figure 1: US recessions and Investec two year ahead recession probability model

Forecasts are inherently limited and not a reliable indicator of future results.

Source: Investec Asset Management, 31.08.19.

Misbehaving drawdowns

We think the nature of markets has evolved since the global financial crisis. Our analysis of markets since 1987 (the year of the Black Monday crash) shows that before 2009, outside of the ‘bear markets’ often associated with recessions – when stock markets drop 20% or more from recent highs – investors tended to see drawdowns that were ‘well-behaved’: an equal weighted bond-equity portfolio suffered very few drawdowns of more than 5%, and never as much as 10%.

By contrast, in the current cycle we have so far seen six episodes of more than 5% drawdown including one of more than 10% – an unprecedented frequency and magnitude of drawdown for a bull market over the last 30 years. This can be seen in Figure 2.

Figure 2: Drawdown of an equal weighted bond/equity portfolio

Figure 2: Drawdown of an equal weighted bond/equity portfolio

Source: Bloomberg and Investec Asset Management, 31.07.19.
Drawdown of equal-weighted portfolio refers to MSCI ACWI & WGBI.

Is a changing market structure to blame?

We think there may be multiple drivers of this increased fragility across asset classes:

  • The rate of economic growth has been slower over this cycle than in past cycles, meaning the global economy has teetered closer to the edge of recession (and therefore to the risk of severe drawdowns) than it did before.
  • To deal with this, central bank market intervention has become more significant and creative than it was previously, potentially leading to a ‘feast or famine’ environment for liquidity.
  • The ability of private sector banks to absorb risk has been curtailed by regulation and shareholder demand for their business models to become more dependable.
  • Passive ETFs/tracker indices make up a greater proportion of the investor base, potentially leading to more herding into and out of positions, thereby exacerbating market moves.

The number of US-listed ETFs has grown exponentially over the years

The number of US-listed ETFs has grown exponentially over the years

The impact of these changes is evident in the number of ‘flash crashes’ – instances when asset values changed significantly over a short period of time – seen in this bull market. These flash crashes aren’t just confined to equity markets (as can be seen in the timeline below) and are likely a consequence of liquidity becoming more susceptible to drying up than before.

Impact for investors

This changing market structure and the resulting increased frequency in drawdowns has a significant impact for investors. This risk is particularly relevant for those investors whose horizons are not aligned to the economic environment but rather to their own specific needs for returns, as their assets may not be able to recover from a drawdown in time to meet their liabilities.

One cohort of investors particularly impacted are retirees, or those approaching retirement. These investors are not able to rely on future earnings being able to fund shortfalls caused by investment losses and so have to depend on the assets they have already built up through their working life. With the world population ageing, these investors are living for longer and so need to make their wealth last longer. For these investors, drawdowns can be fatal to their investment objectives.

Recent flash crashes

Recent flash crashes

Source: Redburn and Investec Asset Management, 31.08.2019.

Figure 3: Drawdowns – what is needed to recoup losses

Drawdowns – what is needed to recoup losses

The value of investments, and any income generated from them, can fall as well as rise.

Source: Investec Asset Management, for illustrative purposes only.

Why defence makes sense

The Global Multi-Asset Income Fund focuses on defensive returns, which we define as having a lower downside capture than upside. We believe this focus makes sense irrespective of the market backdrop to investments.

Figure 4 shows the peak-to-trough performance of the Fund and its peers in the most severe recent drawdown episodes. The blue line shows the least dramatic falls during these challenging periods, meaning our approach shielded against capital losses more so than our comparative peers. By then ‘un-hedging’ risk when appropriate, we were able to recover losses more quickly and so avoided the worst of the negative impact.

Figure 4: Peak to trough performance during drawdown episodes

Figure 4: Peak to trough performance during drawdown episodes

Past performance is not a reliable indicator of future results, losses may be made.
Calendar year returns for the Fund; 2018: 0.5%; 2017: 6.0%; 2016: 4.4%; 2015: 0.9%; 2014: 3.7%. Highest and lowest returns achieved during a rolling 12-month period since inception: Aug-14: 8.7% and Feb-16: -2.8%.

Source: Morningstar, 31.10.19. ‡See the Important information section for more detail.



For investors, the benefit of investing in a defensive fund during a recessionary period should be clear, as the aim to reduce drawdowns in significantly falling markets makes it easier to regain capital in the future.

However, with market structure changes leading to the increased frequency and magnitude of bull market drawdowns and flash crashes, a defensive strategy has an important role in an investor’s portfolio throughout the cycle, particularly for those investors with nearer-term liabilities and needs.

We believe this is why defence always makes sense.

John Stopford
John Stopford Head of Multi-Asset Income
Jason Borbora-Sheen
Jason Borbora-Sheen Portfolio Manager, Multi-Asset

Important information

All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. The fund is a sub-fund in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act.‡Period shown is since 30 November 2013. Performance is net of fees (NAV based, including ongoing charges, excluding initial charges), gross income reinvested, USD. If the share class currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. The MSCI ACWI Index is included to illustrate prevailing market conditions/events. The competitors shown for comparison purposes are the five oldest funds in the Morningstar USD Cautious Allocation category.Indices are shown for illustrative purposes only, are unmanaged and do not take into account market conditions or the costs associated with investing. Further, the manager’s strategy may deploy investment techniques and instruments not used to generate index performance. For this reason, the performance of the manager and the Indices are not directly comparable.If applicable MSCI data is sourced from MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Issued by Investec Asset Management, November 2019.

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