What are some of the long-term structural changes from the COVID-19 pandemic?

While the battle against the COVID-19 pandemic is likely to continue for some time, many investors are already thinking ahead to some of the potential structural changes that would impact the investment landscape. Even if there are still plenty of unknowns, it is important to consider some of the potential long-term implications. 

Firstly, risk-free rates and cash returns are likely to stay low for an extended period of time, as we expect the recovery process from COVID-19’s economic fallout to be gradual. The surge in fiscal debt in developed economies as a result of fiscal stimulus support would also constrain the pace of policy rate normalization. In addition, more developed economies are adopting zero rate policy and asset purchases. This implies that the hunt for yield and income is likely to intensify. 

Secondly, various sectors could see a “social distancing premium/discount” built into their valuations. It might take another year or two to fully overcome COVID-19, but businesses and households would have developed a game plan to handle future outbreaks. Moreover, some consumers or businesses may not fully return to the pre-pandemic way of communicating and consuming. Industries that help to facilitate social distancing, such as online services (retail, financial and education) are likely to benefit more in the long term. In contrast, industries that rely on people movements, such as airlines, travel and leisure, and brick and mortar retailers, may need to evolve and improve their resilience in case another outbreak occurs. 

Thirdly, globalization should still prevail but could take a different form. China is expected to remain a crucial hub in global manufacturing due to its domestic market and robust infrastructure. Nonetheless, chief executive officers could explore other markets to diversify their production and supply chain, given the concentration risk exposed during the initial phase of the outbreak in China. The ongoing geopolitical tension between the U.S. and China is another consideration regardless of the outcome of the U.S. presidential election in November. 

Finally, the COVID-19 pandemic has put corporate social responsibility even more under the spotlight. How companies treat their workers, the local community and the environment will be scrutinized by regulators both in their home country and host countries. This will coincide with a greater emphasis on Environmental, Social, and Governance (ESG) factors by international investors. This could impact on corporate earnings in the short term, but also provides a landscape for quality companies with high ESG standards to outperform. 

EXHIBIT 1: ASSET CLASS YIELDS

Source: Alerian, Bank of America, Bloomberg Finance L.P., Clarkson, Drewry Maritime Consultants, FactSet, Federal Reserve, FTSE, MSCI, NCREIF, Standard & Poor’s, J.P. Morgan Asset Management. Global Transport: Levered yields for transport assets are calculated as the difference between charter rates (rental income), operating expenses, debt amortization and interest expenses, as a percentage of equity value. Yields for each of the sub-vessel types above are calculated and respective weightings are applied to each of the sub-sectors to arrive at the current levered yields for Global Transportation; asset classes are based on NCREIF ODCE (Private Real Estate), FTSE NAREIT Global/USA REITs (Global/U.S. REITs), MSCI Global Infrastructure Asset Index (Infrastructure Assets), Bloomberg Barclays U.S Convertibles Composite (Convertibles), Bloomberg Barclays Global High Yield Index (Global HY bonds), J.P. Morgan Government Bond Index EM Global (GBI-EM) (Local EMD), J.P. Morgan Emerging Market Bond Index Global (EMBIG) (USD EMD), J.P. Morgan Asia Credit Index Non-investment Grade (Asia HY bonds), MSCI Emerging Markets (EM Equity), MSCI Emerging Markets High Dividend Yield Index (EM High Div. Equity), MSCI World High Dividend Yield Index (DM High Div. Equity), MSCI Europe (Eur. Equity), MSCI USA (U.S. Equity). Transport yield is as of 31/12/19, Infrastructure 30/09/19, EM High Div. Equity and DM High Div. Equity 31/03/20. Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia. Data reflect most recently available as of 30/04/20.

Investment implications

The persistently low yield environment is nothing new. Investors have been looking to generate income via fixed income, as well as high dividend equities, in the past decade following the global financial crisis. A challenge now is that, at least in the near term, equities’ dividend yield is threatened by weak earnings and moral suasion by regulators and politicians. This calls for a more active approach in selecting companies with more consistent earnings and dividend policies. Asian high dividend equities remain a bright spot considering the broad range of companies to choose from. Alternative assets, such as real estate and real assets, can also provide income with low correlation to risk assets. 

With regards to the greater emphasis placed on corporate responsibility, coupled with the new world of social distancing and globalization, company selection becomes critical. Companies in technology and communication sectors are in an advantageous position to support households and businesses to stay connected without meeting face-to-face. This points towards the U.S. and Asian technology sector, especially in terms of providing solutions to the business sector and online services to consumers. On globalization, Asia remains an important part of the global supply chain, considering their logistics infrastructure and potential market size of domestic consumers in South and Southeast Asia.