In this call recording, Simon Quick CIO, Christopher Moore, Head of Investment Research, Wayne Yi, and Head of Financial Planning, Bill Lalor, discuss the market downturn in light of the coronavirus. Please feel free to reach out to us with any questions.
The below transcript was produced using a transcription software and may not be verbatim. Please refer to the video recording for exact phrasing or increased clarity.
Darcy O'Brien: [00:00:00] Good afternoon and thank you for joining us for today's live call weathering the Corona virus market downturn. My name is Darcy O'Brien and I am the chief marketing officer at Simon quick, and I'll be moderating today's discussion. Our goal in hosting these calls is to help you capitalize on the changes we have been seeing in global financial markets.
We also hope to address any of those financial concerns that may be keeping you up at night. So please do not be shy and use the Q&A function on zoom to submit your questions. You may also submit questions by emailing me at firstname.lastname@example.org. I'd also like to mention that there is a visual component to this call, so if you have access to a screen, go ahead and click on the zoom link, which will allow you to see my video and slides with some useful information.
Lastly, this call is being recorded and will be posted to our website and circulated over email tomorrow. Now, before I dive into the questions, please note the following disclaimers. This presentation is for information and discussion purposes only. Please remember that past performance may not be indicative of future results and there is no guarantee that the concepts and ideas discussed during the presentation will be profitable or prove successful.
Now let us introduce our panelists. Today we have with us our Chief Investment Officer and Managing Partner, Chris Moore.
Chris Moore: [00:01:31] Thanks, Darcy. Happy to be here.
Darcy O'Brien: [00:01:33] Hi Chris. We also have our Head of Investment Research, Wayne Yi.
Wayne Yi: [00:01:37] Hi Darcy.
Darcy O'Brien: [00:01:40] Great to have you, Wayne. And lastly, we have our Head of Financial Planning, Bill Lalor.
Bill Lalor: Hi Darcy.
Darcy O'Brien: Hi Bill. So, I'm going to start with the questions we've received over email and then we'll dive into the queue and respond to questions in the order in which they were received. Our first question comes in from Rowan. I have heard you say that you're underweight, cyclicals such as small cap and emerging markets. At what point will these areas become opportunistic and a follow on to that? What about financials and energy?
Chris Moore: [00:02:16] Thanks Darcy. I can take that one. Yeah, as a reminder to those on the call, we are underweight cyclicals and overweight higher quality. And within the cyclicals area where we're underweight, small cap and emerging markets are included.
So, we're not entirely out of small cap and emerging markets. We've just shifted exposure, from those areas within equities to more higher quality companies, where some sectors where we are now kind of overweight aretechnology and healthcare. As we think about, when small cap and emerging markets might become interesting again, I would just highlight, you know, despite the runup in the market since the low on March 23rd, you know, we're now equities are up 25% or so.
We're not out of the woods yet. There's still plenty of uncertainty within the economy as it relates to, unemployment and GDP growth, and when those will begin to normalize again. We also have an earning season ahead of us for the second quarter, which, at this point, a lot of companies have stopped giving really any guidance because they can't accurately, say what's going to happen in the next quarter or two quarters or four quarters based on what happened with the virus and when states will be opening and businesses will be allowed to reopen again. So our view is, emerging markets and small cap and more cyclical names. We’re still not putting fresh dollars to work there just yet. We're not increasing our exposure. We want to get through kind of the next quarter or so or two, before we start shifting risk, in those areas. We just think there's, there's too much uncertainty, to be taking that kind of a position within the equity portfolio. That being said, we still remain, target weights, equities. So we have just positioned the equities in a different way with the focus on quality.
With healthcare, being potentially a multi-year theme for us, as we rebound after this pandemic and dollars are put into the healthcare as an industry in preparation for quite frankly, just being better positioned, for future potential pandemics, so that we're able to weather the storm, not just this fall, but later, the next one, better. And technology as a, as an industry, there are certainly sub sectors we like better than others. but that's a multi-year theme too. And we think we'll likely have exposure there, for a while within energy and financials, which was also part of that question.
Financials are incredibly attractive from a valuation perspective right now. Well-run company's balance sheets are sound but, the truth is with interest rates so low, it's very hard for the large banks and financial institutions to generate much in the way of return, because their net interest income, is low based on the low rate environment.
So, you know, there isn't a whole lot of kind of optimism around financials as a sector, because of that. And they too, they do tend to be cyclical in nature, but you know, purely from evaluation basis, they are cheap and fundamentals are sound. So energy is kind of a different story. A highly volatile sector, very out of favor, you know, with concerns around excess supply.
And demand really falling off a cliff. Energy as a sector has certainly taken a beating until the last week or so where it's rallied a bit. We're still cautious on energy as a sector and have not been allocating to that area really at all. So, I don't envision that changing anytime soon.
Darcy O'Brien: [00:06:55] Thank you, Chris. Our next question comes in from Lena. Does it make sense to sell equities at this point? Simon quick increased our equity target when the selloff occurred so clients may now be overweight equities due to the run-up. Should clients be thinking of trimming back?
Chris Moore: [00:07:14] So most clients, were underweight heading into the decline and when we did add exposure, got them closer to a target weight. However, you know, even despite the rally, it was not like every client increased their equity exposure at the absolute trough. It was over a multi week period where we were able to get that implemented. So, in working with your client advisor, it’s probably best for you to kind of talk to your client advisor about what is most appropriate for your particular situation.
But I'd be surprised if we have a lot of clients that are heavily overweight, their target to equity exposure right now, maybe modestly. But you know, that that's kind of something up to you and your client advisor to determine whether or not it makes sense reducing exposure. As I said, for the previous question, we still like equities here, within kind of the market caps and styles and regions that we've said are appropriate for client capital. But we're, you know, thoughtful, certainly to every client's specific risk profile and needs. So we would suggest you kind of speak to your client advisor about what's appropriate for you.
Darcy O'Brien: [00:08:43] Thank you, Chris.
The next question comes from Ross. When you refer to repositioning the SQ global equity portfolio to higher quality, what do you mean? How do you define higher quality?
Wayne Yi: [00:08:58] Yeah. This is, Wayne, I’ll touch a little bit on that. Some of the, kind of sematic, allocations that we had within our equity portfolio is to kind of balance the quality slash defensive with growth allocations. And that would, that goes on the comments Chris made about our exposures to tech as well as healthcare. The quality allocation or the quality theme kind of falls along inside that. And well, there is a somewhat more diverse kind of framework in terms of how people or investors think about quality. So some of the more consistent elements of that is that they're looking for businesses before you think about pricing, or stock valuations. What they're thinking about is, are these companies that have resilient revenues, so kind of good visibility on, kind of revenue generation through multiple periods.
As well as good profitability or cash cashflow and low utilization of financial leverage. So really what that means, our businesses, that you, you have a good sense of where the earnings are coming from and how sustainable those businesses are without a lot of financial risk when, in periods like this where kind of credit risk spikes and it's hard to get access to capital that ultimately results in companies that tend to have our stocks that tend to have, lower, volatility versus it's respected benchmarks. So if we're thinking about the SNP stocks that just tend to not have the same kind of a up or down, notably beneficial in terms of heightened volatility.
So I would say the quality theme is a overweight, to stocks that have a higher quality or better visibility on top line with good operating margins with lower leverage. Which may mean that maybe the top line doesn't grow as quickly so in a big expansionary market, those would probably lag, but in a uncertain or declining market, the top line and the businesses tend to hold it in better.
What of the majors we utilize in that space. Also, kind of parlays out with a, a value component as well. So within that quality framework, companies that might be more attractive from a multiple perspective as well, too. kind of lean, let's say going to lean or tilt a little bit more towards the value construct, with that quality theme.
And what that results in from a sector perspective is a greater emphasis on consumer staples, healthcare. You say real estate and financial fall in there too. A two critical comment about being a underweight financial, yeah, like banks and credit sensitive and interest rate sensitive businesses, would fall within this financial bucket, which we want to shy away from.
But there are, when you think about that financials, kind of bucket, there's a lot of stuff in there. Kind of like a Berkshire Hathaway falls within financials. And Berkshire is not a bank that you have insurance, but it is a conglomerate, type business. So you get diversified exposure with significant cash on the balance sheet to be able to deploy, his most recent, presentation.
He's been kind of holding steady here, but, that kind of resiliency and balance sheet makes sense versus a bank that is levered. So that's kind of how we would define our quality allocation and kind of aligns with the themes around healthcare and tech.
Darcy O'Brien: [00:12:41] Thank you, Wayne. The next question comes in from Maureen, given the current crisis is now the time to buy life insurance?
Bill Lalor: [00:12:50] Thanks Darcy, this is Bill, I'll take this one. You know, the decision to buy life insurance really depends on your personal situation. My general thoughts is that if you didn't have a need for life insurance you probably don't have any for now but with that said, if you haven't had the conversation with your financial advisor regarding your life insurance coverage, now is a good time to do it. You know we view life insurance for our clients having two real main functions, first being income replacement. And, you know, that's obviously to cover loss income to your family should something happen to you. You know, this type of coverage is generally a pain through like a temporary or term policy.
Which are fairly easy to get and tend to be relatively inexpensive. You know, sometimes you do see someone that was relying on a group policy through employer for this type of coverage, which is then lost along with the job. And, you know, for this reason I normally recommend, again, relying on a group policy for income replacement coverage.
You know, the second main function we see for licensure is estate planning, right? And that's to create liquidity. Whether it be for state taxes, generally funds passed the next generation to fund a trust and so on. You know, if this crisis has highlighted anything, it's the importance of making sure your estate plan is up to date.
You know, in an a permanent insurance policy may be an integral role. So if you do have a need for coverage, now is a good time to get it. You know, life insurance premiums are going to be increasing and this is not because of COVID directly, but because of the prospects that we're going to be in a continued and prolonged low interest rate environment.
Low interest rates in the past, the rates that are credited by insurance companies, you know, to permanent policies such as whole life or guaranteed universal life policies. you know, we've seen in recent years, dividend rates from insurance companies have dropped significantly.
This is probably going to continue in the near future. You know, so this really shows the need that your life insurance coverage needs to be managed it needs to be reviewed and assessed periodically. Also, if you have older policies, you know, you should really make sure they're reviewed and that so that they're still going to provide the coverage that you need and expect. Because This crisis may not be the, you know, the times to buy life insurance, but it's definitely the right time to review your needs with your financial advisor.
Darcy O'Brien: [00:15:46] Thank you, Bill. The next question comes in from Michael. What will be the impact on real estate and private equity funds? Should I commit to illiquid now or wait a year or two as more opportunities present themselves? How quickly will the managers call and put capital to work?
Wayne Yi: [00:16:06] This is Wayne. There's two points there, so we'll probably break it up then, Chris might chime in in a couple of minutes of that as well, but, maybe thinking about real estate first, and then the different elements within private equity, thereafter. Then we can talk about the opportunity set, but on real estate, obviously, everyone working from home and not in their offices or not in their stores or not shopping or visiting stores, again, it's pretty self evident in terms of like the, the pain that real estate is experiencing, in terms of, traffic or utilization.
Now that doesn't flow directly or immediately, to the rent line. But where you do see is that retail has the remained under pressure, even pre-COVID with the disruption of technology. so, retailers and malls and strip malls, all that, they've been under a fundamental, pressure even prior to this.
And obviously the stay at home measures, it further exacerbates that element and there continues to be pressure from that side. Overall we've been bearish on retail. Traditional retail. So I have avoided and sought managers that avoided a lot of retail exposure, or retail exposure that was kind of, traffic driven as opposed to, needs or lifestyle driven. Office, same thing that will come under pressure because people are realizing that they need, or that they can tell commute more often where they, where otherwise it was less of an ideal and when you do return to work, what does office is look like? Obviously you need more space per individual, but you're probably unlikely to pay the same amount of square footage per person. So all of that does impact the real estate sector. Well, industrial does well, right?
Industrial should be doing well because logistics and delivery from the supplier to the consumer is becoming ever more important. Whether it's a fresh groceries to toilet paper, to your conditional appliances and technology and additional monitors and keyboards, what have you. So, I think it's hard to just kind of put a broad brush on it but at the end of day, there is a fundamental impact that is to the downside. It will, the more defensive being multifamily and industrials should hold in better. and show a little bit more resilience. But there is a lot of blocking and tackling that we're seeing at the operator level to make sure that, the, the value of the real estate longer-term should be sustainable.
What we have seen versus an ‘08 situation is that leverage has come down and credit or, and bankers are more willing to work with the equity sponsors. Because this kind of caught everyone off guard, even if you're conservative, it just really kind of transit change the operating profile of these businesses.
So yeah, there's a little, I think there's probably more collaboration, better to, kinda get paid six months from now, but get paid in full than sending someone into bankruptcy and then being uncertain what your full recovery would be on that. So there is more collaboration, and working together.
But, operators are trying to manage through that. And that echoes with private equity generally. Like, we won't touch too much on the venture or growth or some are more idiosyncratic strategies. But looking at middle market buyout. High quality businesses that are performing well. They've gone through a kind of major transition and operating restructurings and are worth a lot more than on entry.
Just got their IPOs or their sales delayed. Obviously that does change IRR even if you get the same price or you change your returns, even though you get the same price and they push it out another six months or what have you and then businesses that are sensitive in the sense of medical offices.
We always talk about the dental business where it's a high quality business with recurring revenues, with a known secular growth need. But that just have no patients right now. Is that a bad business? probably right now it is because you have no revenue. But over the long term though, they are sustainable businesses.
So there is the sourcing of capital across credit facilities and business lines with expectation that as a recovery, you'll pay back those lines. And once again, lenders are working with sponsors kind of get through this time. Bad businesses will be bad businesses regardless so those will go through bankruptcy. But high quality businesses where they're in a temporary, kind of pressure point, there is more of a collaboration there, and utilization of balance sheet to kind of, whether through this period. Maybe the final comment just around if it’s a better time versus next year.
I would say this is a great time to be investing in private equity because you don't put your $1 commitment fall into a deployed all at once. I would say transactions are still pretty light right now as buyers and sellers are trying to find the right floor and the right valuation. But we take comfort in knowing that our underlying managers are prudent and long term oriented and always looking for good opportunities and deals to enter.
And that will take multiple years. Private equity does not deploy the full commitment within one or two or three quarters. It takes multiple years for that capital to be deployed. And I think stabilize, maybe there'll be a reinstallation of capital, but making the commitment now, I think particularly some of the managers that we have, we have a growth equity manager that focuses on healthcare and technology and technology enabled businesses.
It's a brand new fund with no risk in the portfolio today. It's just a fresh pool of capital that I think is highly opportune to be able to be deploying into right now in that middle market or kind of buyout space. So, I don't think he tried to time private equity. I think the current vintages will be great, and we'll have to see whether or not it persists into next year. But, this'll be a good opportunity.
Darcy O'Brien: [00:22:50] Thank you, Wayne. While we're on the subject, we've gotten a question in from Steve who asks, did you see a change for private equity partnerships in the anticipated timing for capital calls and for harvesting investments?
Wayne Yi: [00:23:06] Harvesting gets a little bit tougher right now because deals, or indications of interest, the things just get pushed, right, because, you don't know, what's the new dynamic of that businesses. So everyone has taken a pause and I think he sees that, I've seen that in the public markets as well as in the private markets.
But that will come back once you kind of know what you're buying and resilient businesses will still attract interest. And maybe you're tweaking multiple, a little bit here and there, but good businesses will still want to be bought up. So, that's why I've made the comment that it probably delays transactions, but high quality businesses will still be bought and be rolled up and acquired.
We tend to focus on middle market, smaller middle market opportunities that are the acquired as opposed to the ones that are trying to acquire and we feel like we have a high quality portfolio there to benefit from transactions when they do come back and then do I see a change?
What we are seeing though is there is more, interestingly, there's more, private/public partnerships where private capital is coming into public businesses or near public businesses to provide transition capital in this time period where company was about to IPO, the IPO just got delayed and they are experiencing revenue shortfalls in the near term, but they're high quality businesses. There's an opportunity to kind of step into provide transition capital, which gives you a floor, which almost gives you like a downside protected participation, in businesses that otherwise you probably wouldn't have been able to get to look so well.
Some of those things are more opportunistic, but, not, not to go all kumbaya here, but it does feel like there is a little bit more of a collaborative nature across, across the private public and kind of banking lending spectrum. Where that does diverge is more on the distress side we're distressed investors.
Typically they're looking for restructuring situations to be able to come in but they've been waiting and they've been a little bit more patient to get capital deployed but those are broken businesses that, kind of need significantly more operational change as opposed to just a balance sheet adjustment.
So, yeah the dynamic is changing and I would say just expand the opportunities that across a lot of different avenues, notably in privates, but also within the credit space. And we still see it within pockets of public equities.
Darcy O'Brien: [00:26:14] Thank you, Wayne. Chris, before we move on to the next question, did you have anything to add on private equity or liquids?
Chris Moore: [00:26:22] Just to reiterate Wayne's point, I think, we are still, big believers of kind of the private markets here. Both the, allocations to private equity funds, whether it's a buyout or growth equity or venture and to private debt whether that's, you know, corporate debt or private debt. Funding private equity companies, we think there are a lot of opportunities because, valuations are still low in a lot of those areas that didn't necessarily benefit from the recovery, that public equity saw over the last couple of weeks in response to the stimulus packages. So we are still a very much big proponents of the illiquid universe and continue to believe it's a critical component of client portfolios.
Darcy O'Brien: [00:27:17] Thank you, Chris. Our next question comes in from Tom. What are your thoughts about energy and how have they evolved over the past year? How has the exposure to energy changed over the past year?
Wayne Yi: [00:27:37] I'll make a couple of comments. Chris touched on this in the sense of a kind of thinking about energy and cyclicals. We had shied away from, let's call it GDP sensitive or commodity or, kind of expansionary or predictable kind of industries because it still is uncertain. We get it, it's cheap, right? You look at energy stocks, you look at financial stocks, industry, industrial, they all look cheap from a multiple perspective. But you, you kind of have to make the call on how that re extension looks. Now just looking domestically economies and businesses and cities are opening back up, which is a great headline.
And it's good to see the recovery from just the foot traffic out there, but it's still not the same. We're not going back to where we were in February. Nowhere near that in the sense that it's still different foot traffic and the engagement and the dollar spend is different when you go, like retail stores are open, but you're still doing curbside.
So you can't go in and try on new outfits and you can't, compare across the broader selection. They might have a take out versus dine-in. And the size of the checks are different. So that will impact the economy, and result in a slower recovery, despite the headline of just kind of reopening and, it'll just be slower. And I think there's still just another dynamic within energy itself where because energy had been so cheap over the past couple of months, you've been kind of picking up all that supply and building up inventory. So how quickly will I read that? It doesn't seem like, or does it? We don't want to make the call that's going to rebound in any, quick and immediate fashion.
And energy, even as a commodity recovers, businesses are now coming under significantly more pressure as well. So even though we see the commodity do well the corporate entities around them are not in the same place and are continually under liquidity pressures, which frankly has been one of the elements that has been impacting banks as well. So it's still early, so we don't feel like we need to be heroes by kind of making that, that commit, that bet on energy we are participating in the, in the broader recovery via high quality equities, and we think you'll get paid, with a higher risk adjusted return in that, in those sectors then, in the more procyclical ones.
Darcy O'Brien: [00:30:36] Thank you, Wayne. So at this time, there are no remaining questions in the queue. I'd like to thank everyone on the line for taking some time out of their day to participate in today's call. Thank you to Chris.
Chris Moore: [00:30:47] Thank you Darcy.
Darcy O'Brien: [00:30:52] and thank you Wayne.
Wayne Yi: [00:30:54] Yeah, thank you
Darcy O'Brien: [00:30:55] and thank you, bill.
Bill Lalor: [00:30:59] Thanks, Darcy.
Darcy O'Brien: [00:31:00] We appreciate all of you sharing your insights with us today. If you have any additional questions that we were not able to address during the call, please do not hesitate to send them to me at email@example.com and we would be happy to address them offline. Thanks again for joining us and have a great evening.
Please feel free to reach out to us with any additional questions.
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