Financial Services Ireland

Unprecedented volatility impacting every type of investment strategy

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Unprecedented volatility impacting every type of investment strategy

With weakening investment returns and an adverse impact on the capital position of financial institutions around the world, liquidity has become a defining issue for asset managers, writes EY’s Muntasir Khaleik for the April issue of Finance Dublin. Muntasir points out that with increased market volatility, uncertainty and illiquidity, valuation of less liquid and private investments has become very challenging. But in the longer-term he foresees firms using this as an opportunity to introduce a comprehensive enterprise and cyber-resilience model to prepare and respond to most forms of disruption.

The outbreak of the coronavirus pandemic is an unprecedented global crisis. As the situation evolves the priority, of course, is the health and safety of people and communities. We are witnessing Trojan efforts to combat the virus on medical, scientific and political fronts. The impact is also being felt by every industry and business worldwide, and companies are taking proactive and measured approaches to safeguard their people and mitigate financial and operational exposure.

For the asset management industry, Covid-19 has resulted in unprecedented market volatility and has had an impact on every type of investment strategy, with large falls in indices and increasing credit spreads. Forecasts indicate that the Covid-19 outbreak will decrease 2020 global gross domestic product from the 2.5 per cent that was forecast in January 2020 to 0 per cent. Even after the virus is controlled companies will face a financial, regulatory and legal aftermath that is not yet foreseeable.

volatility

Market volatility
The rapid spread of Covid-19 has had an immediate impact of weakening investment returns and an adverse impact on the capital position of financial institutions around the world.

Asset managers have seen their share prices fall 20 per cent or more since their February market highs. BlackRock, Vanguard and State Street Global Advisors, the world’s three largest fund houses, have suffered an estimated drop in their combined assets under management of $2.8 trillion so far this year, according to the Financial Times.

Investors are still trying to understand some of the large and unexpected moves in markets, including the correlation between falls in equities, bond markets and commodities. It seems that institutional investors are not being forced to sell, taking a ‘wait and see’ approach while forced selling has largely been the result of the leveraged positions held by hedge funds.

The effects on Private Equity firms have yet to be felt. However, fundraising could be impacted over the near term primarily due to travel restrictions and the inability to carry out due diligence. With the impacts unfolding so rapidly, forecasting models perhaps were not set up to deal with this scenario.

The Covid-19 pandemic has resulted in PE firms setting up financial lifelines for their European holdings, providing emergency loans or buying debt back off the companies they own. Some large private equity firms have deep enough pockets to strengthen their businesses during the crisis while others are raising funds from investors to take advantage of distressed opportunities and to buy assets economically.

Firms are taking a number of steps to respond, including limiting travel, adding pandemic-related language to new deal and fundraising documents, and deploying additional operating resources to work closely with firms in functions like supply chain.

Liquidity
Liquidity has become a defining issue for asset managers. Covid-19 has resulted in considerable uncertainty as to the extent and duration of lockdowns and significant curtailment of normal economic activity, including business closures, bankruptcies and job losses, triggering events requiring impairment assessments and reduction in the liquidity.

With increased market volatility, uncertainty and illiquidity, valuation of less liquid and private investments has become very challenging. The increased valuation uncertainty, as well as significant pressure on fund liquidity as investors look to redeem or reallocate holdings, pose challenges for asset managers. In response, they have started to take significant protective measures, such as gating or suspending investment funds to ensure equal treatment between investors.

The regulators have also imposed additional reporting requirements. The Irish and Luxembourg regulators have been investigating the ability of investment fund managers to meet large investor redemptions and the SEC in the US has asked whether funds have experienced any delays in, or concerns with, pricing services providing daily prices.

Business continuity and resilience
Maintaining operational resilience has led to asset managers taking actions including split teams​, mandatory working from home, creating dedicated Covid-19 taskforces​, use of disaster recovery sites, increasing focus on the operational risk and control, environment exacerbated by remote working,and increasing oversight and communication with third-party providers, including administrators, custody, pricing and other services.

To navigate this challenging environment asset managers should focus on better communication, enhanced stakeholder relationships and more transparency with service providers and investors.

Over the short term, this outbreak is supporting a shift towards online distribution and testing business continuity policies. Over the longer-term firms should use this as an opportunity to introduce a comprehensive enterprise and cyber resilience model to prepare and respond to most forms of disruption.

It is challenging to predict the extent to which the asset management industry will be affected because it is not clear how widespread the virus will become or how long it will take to contain but the outbreak may serve as a wake-up call to challenge traditional thinking. Building confidence and trust will be a critical differentiator as asset managers respond to and rise from global disruption.

This article was written by EY Director Muntasir Khaleik for the April issue of Finance Dublin. See our latest insights and thinking to support you in leading through these volatile times. 




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