The Covid-19 Pandemic was the dominant force impacting the global economy in 2020, leading to the first recession since the Global Financial Crises and most severe global recession since World War II. Despite the headwinds from Pandemic-related shutdowns, unprecedented Central Bank measures and large fiscal stimulus packages both in the US and abroad helped guide equities higher for the year.
• Pandemic shutdowns led to record GDP contractions in the 2nd quarter of 2020
• Monetary and Fiscal stimulus combined with business reopening created record GDP growth in 3Q20
• Economic momentum receded towards year-end amid a worldwide virus surge
• Rapid vaccine development helped buoy markets to end the year
The US economy shrank by as much as 4% to 5% in 2020, with a deep contraction in the first half of 2020 followed by a sharp rebound in the second half of the year. Countries around the world experienced a similar pattern, with the severity of disruption varying based on factors such as magnitude of outbreak, authority of governments to impose lockdowns, and ability of local industries to thrive in a post-Covid world.
In response to the outbreak the Fed slashed interest rates to zero in cuts totaling 150 bps, as well as enacting new loan and credit facilities, reviving GFC-era programs, and implementing an open-ended quantitative easing program “In the amounts needed to support smooth market functioning.” The US Government’s Fiscal response has also been robust, with programs including direct payments to individuals, small business loans/grants, and specific industry support.
The Global economy began 2020 in much the same state as recent years, with an expectation of modest but steady global growth tempered by concerns over US-China trade tensions, a slowing manufacturing base, Brexit, and US political disorder. However, by the end of January alarm was building about a new virus spreading in China, by the end of February global financial markets were in sharp decline and by the end of March much of the world was under lockdown in an attempt to limit the virus’ spread. An oil price war between Saudi Arabia and Russia further complicated the situation, and the result was a global financial market crash in February and March.
The bear market proved short-lived due to a robust monetary and al response from central banks and governments around the globe, along with most countries attaining some degree of reopening and/or adjusting to life with the virus. The introduction of vaccines by the end of the year further cemented the global market turnaround, and despite recent surges in virus cases there is a degree of optimism heading into 2021.
The pandemic largely overshadowed other global concerns in 2020, but many of the same issues remain. In addition to progress on vaccinations and the transition to the post-virus economy, some key items to watch heading into 2021 include the impact of the Brexit deal, a weakening US dollar, and the potential for change in global trade relations with the incoming Biden administration.
The US economy broke its streak of 10 consecutive years of expansion with the 2020 recession. The Pandemic’s impact on employment has been severe, with unemployment rising from 3.5% to 14.7% over just two months before recovering to 6.7% by year-end, with many more unemployed likely uncounted in that figure. The jobs recovery appeared to lose some momentum by year-end as virus cases led to renewed lockdowns and job losses in the month of December.
Core CPI fell to 1.6% by the end of the year, rising off a pandemic low of 1.2% but still a decline from last year. The Federal Reserve formalized a new policy of “average inflation targeting” this year to allow this figure to drift higher in the years ahead. Consumer sentiment fell drastically but remains well above levels seen in the GFC, buoyed by the swift fiscal and monetary response. Personal consumption followed a path similar to the job market, with a sharp decline in March and April followed by a strong but incomplete recovery which lost momentum towards year-end.
The housing market was a bright spot in the US economy, with low mortgage rates and a desire for more space in the remote-work world leading to increased demand. Home prices rose throughout the year, and while demand was strong, weak supply also contributed to rising prices with the US housing supply reaching a 40-year low by September. After sharp declines in March and April, the Conference Board’s index of 10 Leading Economic Indicators rose in each subsequent month of the year.
Broad Asset Class Performance in Brief
• 2020 was a strong year for global equities, with US and Emerging Markets outperforming International Developed Markets.
• US bonds performed well, benefitting from falling interest rates and significant Fed support.
• Hedge Funds had a strong year, nearly matching US equities with less risk in the volatile environment.
• It was a negative year for Commodities and Real Estate, with particularly large pandemic impacts to energy and rents.
Global Equity Update
Global Long-Only Equity
Global Equities rebounded sharply off March lows, with many markets finishing the year at all-time or multi-year highs. Accommodative fiscal and monetary policy continued to provide support as investors were left searching for yield and returns. Volatility throughout the year remained elevated as COVID rallies were met with sell-offs on virus spikes and varying regional shutdowns, alongside the U.S. presidential election. Despite unclear initial election results and ongoing pushback by the current administration, markets rallied through the end of the year.
US Equities posted the strongest returns in 2020 with gains of roughly 20% in the core indices. Adoption of Technology and Health Care to adjust to a COVID dominated environment further fueled Growth over Value for the year, with the Russell 1000 Growth and Nasdaq leading the markets with returns of 38.5% and 43.6%, respectively. Still, Value stocks rallied in 4Q to positive, albeit low-to-mid single digit 2020 returns, led by Small Caps, on renewed hopes for economic rebounds benefiting this more cyclical market segment.
Developed International markets posted the lowest returns for the year as measured by the MSCI EAFE as European markets were challenged by shutdowns and outbreaks.
Emerging Markets advanced on an aggregate basis in line with US markets, fueled by China and India in 2020 despite declines in Latin America and Russia. Foreign currency had a meaningful favorable impact on Developed Non-US equity returns as most major currencies strengthened relative to the US dollar. However, in Emerging Markets, there were a number of currencies that weakened over the course of the year.
Global Long/Short Equity
Market volatility during 2020 was at the highest level in over a decade. While major macro events (US election and Brexit) have mostly passed, other factors (such as COVID and social unrest) keep uncertainty heightened. We anticipate continued volatility to be the norm for 2021. An environment such as this typically helps generate opportunities on both the long and short side, benefitting equity long/short managers.
Equity long/short managers generally had very strong performance in 2020, participating in market up moves while also strongly protecting in big drawdowns. Taking advantage of volatility, to provide both beta and alpha, is exactly what is desired from the equity long/short asset class. Gross exposure started 2020 at a multi-year high, got down to a multi-year low in 1Q and then increased to end the year at almost a ten year peak. Net exposure, which started the year low and got lower during 1Q, increased through the rest of 2020 to end near a decade high. Having both gross and net exposure near highs is a sign the managers are optimistic about market opportunity.
Style exposure was a major contributor in 2020 as momentum/growth outperformed again. Technology and Health Care were again the strongest contributors to performance, and many managers have maintained high exposure to these sectors. Financials and industrials were detractors and remain the most underweighted sectors by managers, as net exposure to value is at an all-time low.
European exposure was low at the start of 2019, partially due to Brexit concerns, and exposure stayed low during the year. One exception was increased exposure to UK in 4Q as a Brexit resolution seemed likely. Asia, driven by tech, was one of the top performers. Exposure to China decreased in 2020 while exposure to other countries in Asia increased.
Global Private Equity and Real Assets Update
Global Private Equity
Much like public equity markets, the private markets were dramatically affected by the pandemic outbreak and subsequent fallout. As 2020 began, private investors were still trying to sort out what, if any, consequences WeWork’s spectacular fall from grace and failed IPO would have on valuations. That conversation was quickly set aside as private equity managers quickly entered triage mode for their existing portfolio companies in March and new transaction activity ground to a halt. The focus shifted from new transaction activity to raising liquidity and reducing cash and burn rates. By the end of the summer, optimism returned as accelerated vaccine timelines suggested something other than a worst case scenario. Although full-year, new transaction activity suffered versus 2019, the second half of 2020 looked much more normal than anyone would have predicted at the end of the first quarter.
Perhaps the two biggest private equity stories of the year happened in public equity markets. Despite a near complete shutdown in 2Q, the US IPO market roared back in the second half of the year. Driven by high profile listings of Snowflake, Palantir, DoorDash, GoodRx, Airbnb and others the US IPO market posted its best year since 2014 and its second best year since the turn of the century. The number of IPOs were up 36% and IPO proceeds were up 68% versus 2019. The second “public” private equity story of the year was the resurgence of SPACs as an alternative investment vehicle. 2020 saw 242 separate SPAC launches. The restart of transaction activity, the reopening of the IPO market, and the success of SPAC and other fundraising channels ended the private equity year on a decidedly optimistic note.
Global Real Assets
2020 began with the backdrop of a 10-year bull run for US Core real estate markets. Over that time real estate investors benefitted from a strong economy and constrained new supply. They were rewarded with annualized net returns of 10.4%. The market outlook changed dramatically in 1Q as public REITs flashed a warning signal for real estate investors. By the end of the second quarter, the NCREIF ODCE index officially ended its bull run by posting its first net negative return since the fourth quarter of 2009. While only a modest -1.75% decline in 2Q, real estate investors still viewed the negative return as a likely sign of further bad news to come. Surprising many, the third quarter of 2020 featured a small positive gain driven by a lower but resilient income return. The fourth quarter return is expected to be the same.
Rent collections suffered across all property types. Apartment, industrial, and office assets fared best with only modest declines while retail and hotel assets felt the full force of lockdowns. Social and economic conditions combined with an inability to conduct traditional on-site diligence led to a decline in transaction volume, a widening bid-ask spread on properties offered for sale, and uncertainty around valuations headed into 2020.
The Bloomberg Commodity Index (BCOM) fell -3.1% in 2020, underperforming the BloomBar US Aggregate Bond Index by 10.6%, the S&P 500 by 21.5%, and the MSCI ACWI by 19.9%. Solid gains for precious metals and many agricultural commodities were offset by another dismal year for energy markets.
Global Fixed Income Update
Global Traditional Bond Markets
In response to a halting economy and freezing liquidity, the Federal Reserve quickly cut the Fed Funds rate to a range of 0-0.25% in March and implemented a wide range of old and new programs. These actions were critical to the market recovery, although risks remain. To reach their goal of 2% inflation, the Fed adopted an average inflation targeting methodology, modifying their language from “targeting 2%” to “averaging 2%.” Given the risks and inflation goals, the Fed has indicated that rates will stay low for some time with the latest Committee forecast anticipating the Fed Fund rates to stay near zero through 2023. After significantly declining, inflation expectations have dramatically improved as seen in the 10-year breakeven yields. In response to falling rates, the yield curve shifted downwards from 2019 levels. With short-term rates now anchored near zero and longer-term rates rising, the curve has steeped from earlier in the year.
After widening to levels not seen since 2008, spreads tightened significantly with IG corporate spreads finishing the year just 3 basis points wider from the end of 2019. The BloomBar US Aggregate index gained 7.51% during the year. Despite a significant drawdown in March, the BloomBar High Yield index finished the year with a gain of 7.11%. Defaults remain elevated though as the trailing 12-month default rate for high yield bonds finished the year at 6.15% with a recovery rate of 18.10%.
Overall, municipals performed well as the BloomBar Municipal Bond index gained 5.21%. Global bonds were mixed throughout the year as the Citigroup WGBI – Unhedged index gained 10.11% and the JPM GBI EM Global Diversified index gained 2.69%.
Global Nontraditional Bond Markets
Despite volatile markets and some meaningful drawdowns in March, unconstrained strategies within our peer group produced an average return of just over 5.6% during 2020. While lacking the higher duration exposure that protected more traditional fixed income strategies during the Covid drawdown, many managers were able to deploy liquidity into risk-sensitive assets at attractive valuations. Managers who were more willing to move into risk-on sectors in late Q1 and early Q2 participated more significantly in the subsequent market rebound. With the short end of the yield curve anchored at low levels, cash plus return objectives are more reachable within a relative value framework. Tactical decision-making may play an increasing role as investors seek return in a low-yield environment. Unconstrained strategies stand to benefit from their ability to seek return away from typical sources rather than reaching for yield in the usual places.
Long/Short Credit strategy outcomes in 2020 were highly dependent on the overall investment style and underlying asset categories within each portfolio. Many strategies generated strong gains for the year, with varying degrees of intra-year volatility. Managers employing a relative value approach focused on traditional corporate credit generally fared the best, with some strategies producing flat or positive returns during the drawdown period in March. Structured credit strategies overall were hit the hardest and were the slowest to recover. Event-driven credit managers endured a degree of pain during the drawdown, but many rallied strongly to post solid year-end results. Relative value-oriented managers should have an opportunity to do well in a yield-constrained environment.
Private Credit strategies (typically five- to ten-year fund life) fared well in 2020 as liquidity forced selling early in the year followed by a second half recovery presented attractive opportunities for dislocation and distressed focused strategies for the first time in years.
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