Currency & Sector Liquidity Analysis Report: Q1 2020

May 25, 2020

The beginning of 2020 will be one to remember. The market panic that resulted in the stock markets’ fastest rate of decline, exceeding that of the 1929 market crash, will be etched into future business textbooks and analyzed thoroughly for many years to come.

It is almost certain that most portfolio managers, with some exceptions like Bill Ackman of Pershing Square, did not expect the deep fallout from the economic impact of the Covid-19 pandemic. By betting that the pandemic would sink markets, hedge fund manager Ackman was able to turn a $27 million investment into nearly $2 billion using credit default swaps. But he’s the exception.

When we completed our fourth-quarter 2019 currency report, funds were almost fully deployed. But since then, we have seen currency levels rise significantly in the average fund. However, due to the speed of this pandemic, most managers were not successful in raising cash quickly enough to offset vast losses, which can be seen in the performance of many ETFs and mutual funds year to date.

Average portfolio weights for world currencies

Our analysis focuses on the Canadian investment fund industry in the first quarter of 2020, and how portfolio managers are allocating capital in major currencies. The currency analysis excludes all cash equivalents, such as bonds with less than one year to maturity and collateral cash held to fulfill debt covenants. We believe by excluding these items, we can home in on the deployable cash in investment funds and assess the street’s market sentiment. We then further analyze the liquidity of investment funds on the basis of cash and cash equivalents, categorized by sector, to help us understand which verticals portfolio managers are currently overweighting and underweighting.

Table 1 illustrates the month-over-month growth rates for the world’s major currencies.

Chart 1 illustrates the mean cash percentage in investment funds for nine major currencies in sequential order from January 2020 to March 2020.

US and Canadian cash on hand

Chart 2 illustrates funds’ mean cash dollar value in sequential order from January 2020 to March 2020. The U.S. dollar had a net position of $3,620,919,899 for March 2020. The Canadian dollar had a net position of $6,202,836,190 for March 2020.

Investment Fund Liquidity Ratio

The Investment Fund Liquidity Ratio is calculated as the amount of cash in a fund relative to its total assets. It is important to assess this ratio when analyzing investments and allocating capital. The ratio has the power to shed light on the overall flow of capital into specific verticals and the bullish or bearish sentiment in these investment categories. Table 2 shows the top and bottom 10 funds out of applicable sectors based on the mean ratio of over 3,000 investment funds with a mandate to invest in the corresponding sectors. Table 2 lists the most bearish to most bullish sectors in descending order.

The red highlights the sectors with the highest ratio, which translates into underweighting their respective indices. This could mean that portfolio managers are expecting negative performance in these categories.

The green highlights the sectors with the lowest ratio, which translates into overweighting their respective indices. This could mean that portfolio managers are expecting positive returns in these categories, in the short term.

Review and outlook

So much uncertainty lies in the year ahead of us, with many chief strategists stating that company-specific bets will be key for portfolio performance. At the time of writing, Inc. (NSD: AMZN) and Apple Corp. (NSD: AAPL) have both beat topline earnings estimates. But analysts are factoring in the uncertainty and the earnings guidance going forward, causing some of these companies to retreat. Netflix Inc. (NSD: NFLX) and Microsoft Corp. (NSD: MSFT), powering increased work-from-home and recreational, use have had some stellar numbers, but also cite increasing uncertainty going forward.

Energy major Royal Dutch Shell (NYSE: RDS.A) reduced its dividend, while ExxonMobil (NYSE: XOM) froze its dividend for the first time in 13 years. It is no surprise that energy companies are in for a world of volatility. Crude oil prices cratered in April (with expiring nearby futures contracts actually turning negative for the first time in history) owing to a price war between Saudi Arabia and Russia combined with the economic slowdown, which created a global supply glut. Only recently has that glut started to drain.

Most investors need to understand that while some of these heavyweights have still beat analysts’ sales and even earnings estimates, the withdrawal and volatility of earnings guidance is troublesome. As Wall Street works on a quarterly basis, the lack of guidance may result in a greater number of positive or negative surprises, which will lead directly into massive pops or steep drops in share prices. Active fund management has become far more important now that market volaltility dominates than it was in the post-financial-crisis world, when a steady bull market prevailed.

When we look at the above charts in totality, cash has been rising steadily from December 2019 lows. This could be a trend as economies around the world deal with these unprecedented times.

U.S. President Donald Trump is predicting one of the greatest rebounds in market history, while many other observers believe that the stock market rallies over the last month may have been overly optimistic. To put it in perspective, the rally during April has effectively recovered more than half the losses in the pandemic selloff. Investors are starting to wonder whether current levels are reasonable, as unemployment is at record highs in both Canada and the United States, and business is likely to resume only partially and over a protracted period, with serious negative implications for employment rates going forward.

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