At the beginning of this crisis, I have not yet decided whether those who argue about closing the public equity market deserve proper consideration or not. After all, everything else is closed so why not do the exchange yourself at least until we get clarity about the economic consequences?
Then I realized how bad this idea was especially after seeing how market areas such as Canadian private equity, debt and mortgages behave in the current environment.
The wonderful thing about investing in the public market is that you get full transparency on prices and more often than not liquidity is not a problem, as long as you stick to larger company shares and / or ETFs. This does not mean that markets do it right all the time because they are famous for misjudging expectations in the future.
However, this can create opportunities for those who want to take advantage of price mistakes when they occur while providing strong lessons for those who give in to emotions and buy superiors for fear of losing or selling buttocks during reticence. At least for the most part, investors can get their money and move to other areas of the market to compensate for the mistakes made.
Fast forward to the situation today, where the public market is still trying to assess the future risk of a fall due to coronavirus, with experts not sure whether assets are overvalued, below or fair enough. As a result, there are large daily swings until some level of uncertainty begins to disappear.
For those who debate the closure of the market until there is some better visibility going forward, we think it’s good to look at less transparent segments, such as private debt and the mortgage market, to determine what the trade-offs are.
Ironically, because their assets are not marked to be marketed regularly and consistently, many private funds have reported a linear return profile which consequently offers what is called “low correlation” with traditional portfolios.
This works until major events occur such as this sending the mortgage market into full chaos and putting asset prices very risky.
To add a few perspectives on how dire the situation is, nearly half a million Canadians have asked for a mortgage suspension and missed payments in just the past two weeks, according to a report by the Canadian Bankers Association. In total, the six largest banks in the country have suspended more than 10 percent of mortgages in their portfolios. So ask yourself, how would a private mortgage company and smaller debt investment fit into this environment?
Although there is much disclosure about the depth of the situation in the US private debt market, we are surprisingly rarely heard of this in Canada even though our shadow banking market is valued at more than $ 1.5 trillion and represents 10 percent of total financial assets, according to the Bank of Canada. The closest thing we have is the Canadian public REIT, which has sold nearly 30 percent this year while publicly listed high-risk lenders such as Home Capital Group and Equitable Group are down 50 to 60 percent – something to keep in mind when looking at the value of net assets your personal funds on your final quarter report.
Conversely, if this is a public market with full transparency there will be differences between good and bad private debt managers. Investors can finally have the ability to scrutinize the quality of these investments and fund managers and make appropriate reallocations into assets that are able to withstand this collapse, and sell which may not last. If the funds are oversold well this might even be a good buying opportunity for real estate that is less heavy in their portfolio, which we think is a great diver.
That said, nothing really matters because the markets are basically closed, the liquidation is likely to be gated and that is the roll of the dice on how valuations will ultimately look in the coming months. If this is the case if the equity market is closed, then that’s really a bad idea.
Martin Pelletier, CFA, is a Portfolio Manager at Wellington-Altus Private Wealth Counsel Inc. (formerly TriVest Wealth Counsel Ltd.) Private clients and institutional investment companies specializing in discretionary risk-managed portfolios, investment / supervisory audits and tax and sophisticated estate planning.
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