At the start of 2020 many people around the world were gripped by images coming out of Australia. Mask-clad people were choking on the smoke of the worst bushfires in living memory in front of normally bright-blue water. Nobody knew that mask-wearing would soon become ubiquitous around the world.
It wasn’t until February that countries started to realise the significance of the Covid-19 outbreak. As fears started rising, the panic spread to financial markets. It was the ultimate black swan event for many investment managers, with nobody predicting the chaos this once-in-a-generation pandemic would cause. The S&P 500 fell more than 30% and $481 billion was withdrawn from global fixed income marketsp1.
For DNCA, like so many others, Covid did not start well. Around one-month after the start of the market correction its flagship fixed income strategy, Alpha Bonds, suffered its biggest drop since the strategy started eight years ago. Of course they were not alone in this, most equity and fixed income strategies experienced sharp drops. However, it was at this time of crisis that one of the key aspects of the alpha bonds strategy came to its rescue, its flexibility.
Swift portfolio repositioning the key to the turnaround
At the time of Covid-19 the DNCA Alpha Bonds team was anticipating solid global growth following the resolution of the US-China trade war and so had a short position in (nominal) G10 government bonds and a long position in Treasury Inflation-Protected Securities (TIPs). However, when the Covid-19 pandemic hit, everything changed. The market crashed as central banks slashed interest rates to zero and inflation expectations plummeted, adversely affecting both of these positions.
From February 17 to March 18, 2020, the Fund dropped -13.3%, its maximum drawdown (biggest loss ever). However, the flexible setup of the fund and its high liquidity enabled it to quickly adjust to the new market conditions. The team closed its short position in G10 government bonds and shifted to long G10 government bonds, while maintaining its long position on inflation, with US TIPs. One of the reasons the Fund has such flexibility is because it invests in highly liquid securities like G10 government bonds. Its Bloomberg liquidity score is a high ~90%. You can see in the graph below the big shift it made in duration and overall positioning in early 2020.