1) In light of the volatility in the markets, what should investors do with their portfolios?
The level of volatility in the markets is at a peak not experienced since the Global Financial Crisis. Having invested through many crises before, the most prudent approach during such volatility is to stay invested. If you consider the path of returns last week, with March 12, 2020, being the worst day since Black Monday and the following day the best day since October 2008, it is virtually impossible to time these markets successfully. Investors should take comfort in BBH’s tried and true investment philosophy. We entered this crisis with a portfolio of high-quality companies that have strong balance sheets that give them staying power. Although many of these companies will suffer declines in earnings over the next few quarters, these businesses are well positioned to ultimately thrive over the long-term. Our managers have taken this opportunity to deploy cash into securities whose prices have significantly dislocated from their underlying values. In discussions with one of our managers, he noted: “Optimism is the enemy of forward-looking investment returns, panic their great friend.” We will continue to take advantage of attractive opportunities, as we seek to provide our clients with the most optimal long-term returns.
2) Why are municipal bonds not protecting capital currently?
Up until a week ago, municipal bonds were performing like a safe haven asset similar to Treasuries. Clients benefited from extending the duration of their municipal bond portfolios in mid and late 2018, as rates have declined significantly since that time. However, that dynamic changed this week as equities moved sharply down. We believe that this pressure is from forced selling of retail municipal bond funds; municipal bond funds typically don’t carry high cash levels, and so outflows result in forced selling in the market. This of course doesn’t mean that the bonds are not money good, but that they are just absorbing the selling pressure. A similar dynamic occurred at the end of 2008 when muni/Treasury ratios, which typically hover around 80-90%, spiked to over 175% before settling back down into their normal range relative to Treasuries in the span of several months. Accordingly, we think this price pressure will likely not last and municipal bond yields will likely come back down. In the meanwhile, we are looking at this forced selling as an opportunity to buy high-quality issues at attractive yields.
3) What effect does the Fed’s action (reducing rates to 0%) have on money market investments?
Money market investments last experienced interest rates this low from late 2008 through late 2015. During that time, net yields were around one basis point for shareholders, as money market fees were waived. We anticipate a similar action within the next couple of months.
4) What is happening in the oil markets? Are we exposed?
In addition to the issues surrounding COVID-19, Saudi Arabia and Russia, two of the three largest oil producers, have engaged in an oil price war. When Russia decided that it would not cooperate in the supply cuts after the expiry of quotas on April 1, Saudi Arabia announced plans to increase production. As a result, oil and energy stock prices marched significantly lower. Given BBH’s preference for non-cyclical companies, we have virtually no exposure to energy in our equity portfolios and very little in our fixed income portfolios. We have long realized that the cyclicality of these companies and the inability to time those cycles is a difficult, if not impossible, task. Many of these energy companies will not survive and file for bankruptcy. We are exploring ways in which we can take advantage of this unfortunate reality in other ways. We will keep you updated as this situation unfolds.
5) How is this decline in the markets affecting our illiquid portfolios?
Given the early stages of the market and economic dislocations that have been caused by the COVID-19 pandemic, the BBH Capital Partners (BBHCP) team has been in regular dialogue with the senior executives of all of its portfolio companies regarding employee safety protocols and emergency preparedness, flash financial performance, potential business interruptions and the liquidity status and potential near-term liquidity needs of each business.
While we believe that the portfolio companies will feel some impact from the pandemic-induced dislocations including short-term earnings declines, we believe that our portfolio companies have considerable staying power, generally operate in industries which are less susceptible to economic downturns and are conservatively capitalized. Given the BBHCP investment approach, our portfolio companies enter this period of uncertainty with reasonably leveraged balance sheets, and the securities that BBHCP owns are generally more senior in the capital structure. Currently, there are no acute liquidity concerns at any of the portfolio companies, although we continue to closely monitor liquidity status with our management teams on a regular basis. To the extent that some of our portfolio companies experience material business interruptions over the coming weeks and months, it is possible that BBHCP will need to support these companies with incremental capital. This is a very fluid situation, and the BBHCP team intends to remain vigilant in our communication with the executive teams at each portfolio company. As always, we are developing comprehensive plans with company management teams to help preserve and grow value and are assisting them to execute against those plans.
BBH has virtually no exposure to real estate currently. Our real estate team has been very disciplined and has only invested in one property in the most recent fund that was raised. As a result, there is significant “dry powder” that can be deployed as dislocations in the real estate markets create compelling investment opportunities.
With respect to private debt, we are now, more than ever, happy that our manager adhered to very strict investment criteria, including imposing maximum debt/EBITDA ratios that had the effect of slowing the pace of capital deployment. As it stands today the onshore and offshore funds are both less than 50% called, leaving ample dry powder to deploy into new deals. In credit markets, the best time to make new loans is often just after a crisis when the loan terms and credit documentation tend to be significantly better. Having said that, we realize that some portion of the companies to whom our private debt manager has made loans will be negatively affected. Our manager’s review of its borrowers is ongoing, but we would note that we are in senior secured positions in the companies’ capital structures and generally have a significant amount of equity below our loans.
Past performance does not guarantee future results.
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