1. Should clients take advantage of this volatility by buying equities?
Our managers are gradually deploying their cash balances into securities whose prices have significantly dislocated from their estimated underlying values. While we recognize that the markets will continue to be volatile and prices may likely decline further, it is impossible to time a market bottom. As a result, we are happy to have our managers invest in strong, high-quality companies that we believe will generate attractive internal rates of return over the long term, regardless of whether these investments are made at an absolute market bottom. We are also recommending that our clients consider rebalancing their portfolios as their equity and fixed income allocations move away from targets by more than +/-5%. Because we continue to believe that there will be volatility in the markets, we are advising that any rebalancing be done in an incremental and gradual way. We will consider adding more equity risk only when we see a more tangible framework for cases to peak, more well-defined fiscal policies and a subsiding of market volatility.
2. Should we engage in tax loss harvesting techniques during this period?
Tax loss harvesting is generally an excellent way to manage taxes and a tool that can be utilized throughout the year. Under ordinary circumstances, a strategy of selling securities with losses and using an S&P 500 Index strategy to maintain equity exposure, can work very well. However, given the extreme volatility in the markets and the dispersion of returns between individual stocks and the S&P 500 Index strategy, the price movements of these two instruments could dislocate such that the result is less than optimal. Given these risks, and the volatility of the markets, we are not recommending tax lost harvesting at this time but are of course available to help clients who are interested in the strategy. As with everything, we are monitoring this evolving situation and will advise our clients if our thoughts change.
3. Your investment philosophy is predicated upon buying securities at a discount to their valuations. How can you know what securities values are given that earnings are so uncertain?
It is certainly true that earnings for at least 2020 and possibly through 2021 will be uncertain and, for most businesses, lower. Many economists, including our own Scott Clemons, are estimating that GDP could decline significantly during the first and second quarters of 2020. As we have stated in previous writings, however, having the ability to look past this short-term disruption and focus on longer-term results (five to ten years) reinforces our belief that most of the businesses we own are positioned not only to survive but thrive. Companies that are managed by strong management teams will seek to take advantage of this volatility by employing tactics like retiring shares at attractive prices and making acquisitions, perhaps at lower prices. Of course, the first priority will be to bolster liquidity. Right now, the most important question our managers are asking is: “Does the business have adequate staying power.” Having strong balance sheets with low leverage and sufficient liquidity is paramount during this period. Eventually, this virus will pass, and things will get back to more normal patterns, but being able to survive is critical. We take comfort in knowing that our managers are being vigilant in asking this question of the businesses they own. Now more than ever, it is key to be able to select the companies that have the resources to survive rather than investing blindly in a passive index strategy.
4. Fixed income markets are in disarray, and credit spreads are widening. What impact does this have on our existing fixed income investments?
Fixed income, even high-quality investment grade fixed income, has been under pressure during recent days with sharp movements in both interest rates and spreads. The Barclays Aggregate, for example, had two of its four worst days since 1989 in the past week. BBH’s fixed income strategies take a credit-oriented approach to investing and have not been spared from recent mark-to-market declines. While much of the market decline is justified by recent events, we believe that some of the selling has been indiscriminate, and in those cases, prices are out of line with their underlying fundamentals. For example, credit spreads of short-maturity bonds have, in some instances, increased more than those of longer-duration bonds of the same issuer, a scenario that does not make rational sense. Forced selling is driving much of the pricing dislocation as short-duration bonds are being used as a source of liquidity. While we can’t say when market pricing will return to normal, we can say that our fixed income managers are seeking to take advantage of these dislocations to purchase high-quality bonds at attractive prices and that we remain confident in our fixed income strategies.
Past performance does not guarantee future results.
Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2020. All rights reserved. PB-03428-2020-03-18