CIO Roundtable (Part 3): The Coronavirus’ Chain Reaction on Asset Allocation, Modern Society, and Portfolio Performance

Bill Coaker, CIO of the San Francisco Employees’ Retirement System: The decline in the public markets is leading to overweights in private markets, but if the downturn persists, there’s going to be some material write-downs in the private markets, and overweights to privates would go away.

The key is this virus needs to be defeated. We need social isolation, to keep our hands sanitized, not touch our face, clean surfaces, test large numbers of people, and ensure health care professionals have all the medical equipment they need, including ventilators, hospital beds, surgical gowns, masks, gloves, wipes, etc. If health care professionals fall ill in large numbers, hospitals become hospices. And all of those don’t cure the disease. They buy us more time, and they slow the spread. To fully defeat the virus and avoid a second and third wave, we need a vaccine. I’m encouraged that we’re practicing social isolation more fully around the nation, which should result in a slower spread of the virus and fewer fatalities. Bill Gates is of the point of view to shut everything down, to shut the nation down, socially isolate at a draconian level, and do that for six to 10 weeks and you will stop the spread and defeat the virus. On the other hand, President Trump and Mayor de Blasio appear to be seeking to resume economic activity. 

The next month is going to be important, to know whether we can begin to resume economic activity late in the spring. I am encouraged that Neil Ferguson in Britain who made the claim that the US would experience 2.2 million fatalities and Great Britain would experience 500,000 fatalities has substantially reduced his estimates. He now estimates that Britain will experience 20,000 fatalities, down 96% from his initial forecast of 500,000 deaths.  He did not make a revised prediction for the US, but if ours also fell by 96%, rather than having 2.2 million fatalities, we would experience 90,000. 

While our daily fatalities will continue to worsen, by April 24, the IHME forecasts our daily fatalities will decline to less than 2,500; by May 1 to less than 1,000 daily; by May 8 to less than 500; and by May 16 to less than 250 a day. The IHME data incorporates the states’ recent social isolation ordinances. There is considerable variation from their base case to their high and low estimates of daily fatalities. But even in their worst case, recent data suggests that COVID-19 will not cause anywhere close to the number of fatalities as initially feared.

Jonathan Grabel, CIO of the Los Angeles County Employees’ Retirement Association: It is premature to know the magnitude of the denominator effect as that is a function of what Bill was talking about in terms of the market impact of this public health crisis. From both a fiscal and monetary standpoint, the government has done a tremendous job. We will not know until after the fact whether the measures are working, but what they’re doing is arguably decisive and big. The government has to thread a microscopic needle—social distancing is, in effect, shutting down a significant portion of the economy, and, in contrast, the fiscal and monetary measures are trying to counteract that slowdown.

It is incredibly challenging to solve these simultaneous equations, but we have to realize that we are all trying to our best as we confront this public health crisis. This will have an effect on investment portfolios. The numerator and the denominator will both be impacted in terms of relative allocations across and within asset categories. In addition, there will be a temporal impact as private valuations are lagged. This will add to the uncertainty as to the denominator effect. 

Scott Chan, deputy CIO of the California State Teachers’ Retirement System: Something Jonathan said struck me, and I agree with, which is the governments and the Fed are doing a tremendous job in inserting liquidity into the markets. The government is being decisive and rolling out a package that’s $2 trillion. I think by virtue of comparison in the 2008 crisis, we spent $900 billion, if I recall correctly. So, this is more than double, and I think it goes back to what Bill was saying that one of the really unique things is we’ve never seen the global economies fall in a coordinated fashion like this before.

When I first was looking at these estimates, I wondered whether the down 10, the down 30% in GDP was an earnings estimate because we’ve just never seen something like that before. But I think what struck me is that essentially there are long-term risks forming even now out of this crisis. I think the first four, five, six years are going to be similar to ’08 and that we’ll be looking for opportunities, if we have a recession and a U-shaped recovery. But once the dust settles, number one you have government deficits increasing. And the deficit is going to be fairly large on state levels as well as the federal level.

So, is that going to eventually become a drag onto the economy for a long-term investor like CalSTRS? We’re going to see some distress. You think about a shock like this and, even though I would commend the Fed and the government for doing what they’ve done, a lot can be missed, right? If you look at the average small business, they might have 27 days of cash. Is the pathway going to allow them to essentially all remain solvent or are there going to be bankruptcies, which is a big part of our economy? And as you look at negative interest rates becoming even more negative across the world, what type of returns do we need on an absolute basis when the “risk free rates” have gone down and are even negative? And so that makes the job of meeting our return hurdles more difficult over the long term. And then, even thinking ahead, but obviously no one is concerned right now because oil is at $26 per barrel depending on the day, with the fiscal and monetary stimulus around the world, could it eventually lead to some form of inflation above our 2% target? That’s a long-term question.

Even as the world is differing in terms of the measures being taking to stem the pace of the virus, we could see some regime shifts across the globe. Some of the long-term risks that we’re thinking about aren’t going to play out in the short-term, or even the medium-term. But, from CalSTRS’s perspective, we’ve got to be thinking about these long-term risks because we’re an ultra-long-term investor.

Ash Williams, CIO of the Florida State Board of Administration: Well, it’s there, and I guess what I would say is to the extent it pushes us—and it could very well in some areas, notably private equity—we could have a situation where you’re suddenly brushing up against being overweight or something of that nature, and my approach to that in the past has been don’t be a slave to asset allocation policy precision. And if prudent suggests that the reason something looks like nominally it should be adjusted, don’t sell down good assets toward that end, recognize it for what it is, which is a technical transient problem and accept a periodic aberration, a temporary aberration in being overweight.

And if that involves taking steps through the governance process to acknowledge it, go do it. But do the right thing on fundamentals and for long-term protection and compounding of capital.