Virus Fallout: Survey points to large-scale bankruptcies and growth of asset mispricing risks

CFA Institute recently published a report about the impact of the coronavirus crisis on the global economy and the investment management industry. Based on a global survey conducted in April, the report details CFA® charterholders’ observations on a wide range of issues, including market liquidity and volatility, asset prices, the shape of the economic recovery, government and regulatory intervention, and asset allocation and hiring changes.

This article focuses on five key themes: market liquidity, asset price formation, government intervention, impact on the financial services industry, and risk of misconduct.

Market liquidity is down

We asked survey respondents to report their experience of trading liquidity across equities, government bonds, and investment-grade corporate bonds, in both industrial and emerging markets.

Generally, the results show that liquidity in equities and bonds in developing and emerging markets has declined as a result of the pandemic. But there were some interesting variations based on asset class and the respondents’ regions.

For example, central bank intervention is seen as more impactful for bonds than for equities. For government bonds in industrial markets, even though liquidity was down, respondents globally and in Asia Pacific (42% and 38%, respectively) reported that the intervention had a stabilising effect.

Intervention, however, had a relatively limited impact on corporate bonds from the perspective of Asia Pacific respondents (30%) versus the global average (40%). For emerging-markets equities, as much as 27% of respondents in Asia Pacific observed a liquidity shock that could result in fire sales.

Increased risk of asset mispricing

The vast majority, or 96%, of respondents globally and in Asia Pacific believe that the lack of liquidity and subsequent purchases by authorities gave rise to mispricing of assets.

In Asia Pacific, respondents were relatively more concerned with liquidity dislocations (45%) over distortions to natural market pricing as a result of government intervention (29%). By contrast, respondents in North America and Europe expressed relatively higher levels of concern about public authorities distorting prices. This probably was due to the significant size of bond-buying programmes in those markets, which many viewed as artificially inflating asset prices.

Risk of asset mispricing complicates fundamental investment analyses. Unfortunately, a sizeable gap is apparent between the real economy and securities markets right now, and it is anybody’s guess as to how much longer this will continue. After all, markets can remain irrational far longer than investors can remain solvent.

These results suggest that investors may wish to be hypervigilant. When markets realise that the real economy is not catching up or is heading toward an even deeper recession — and that realisation may happen swiftly — we will all need to brace ourselves.

Split on intervention

Governments and central banks worldwide reacted strongly to the market volatility in March by introducing a range of monetary and fiscal stimulus packages. Globally and in Asia Pacific, our members liked what they saw and felt that the responses were powerful, swift, and necessary. No consensus was reached, however, as to what should follow.

Some respondents felt that intervention would need to continue to sustain the economy (49% globally and 53% in Asia Pacific), while almost as many felt that it was critical for economies to return to financial discipline as soon as possible (49% globally versus 45% in Asia Pacific). In other words, although everyone recognised the positive effect of the intervention, not everyone agreed on whether it should continue.

Central bank intervention has become par for the course since the global financial crisis more than a decade ago. As intervention becomes more systemic, consistent, and persistent, we may all be growing addicted to it. Over time, it will become increasingly difficult for natural market forces to reassert themselves.

Bankruptcies and consolidation

We were interested to know whether the pandemic would structurally change the industry in terms of the business model, industry structure, or competitiveness of markets. Of the 10 options that were provided in the survey, the ones most selected in Asia Pacific were large-scale bankruptcies, acceleration of automation, and large-scale industry consolidation. These are sobering messages and support expectations that more pain is inevitable in spite of the range of available relief and support programmes.

Two other popular observations were the divergence of development paths between industrial and emerging markets and the reduced globalisation of financial markets and investment flows.

Respondents were relatively less concerned about loss of investor and public confidence in the industry or the return of active investment. Only 6% of respondents globally and 4% in Asia Pacific expected no major long-term impact.

While these results appear to send some bleak messages, some of these trends, such as operations automation, had arguably started even before the pandemic. The crisis has heightened the need for the financial services industry to adapt quickly so that it may survive, and we expect many firms will be making significant shifts in culture, teams, and products as well as in identities.

What does this mean for individuals and their job prospects? It’s probably too early to predict the long-term effects on employment. The share of respondents in Asia Pacific that saw no change in their firms’ hiring plans versus those indicating a hiring freeze was almost the same (43% and 42%, respectively). Only 13% said their firms were already downsizing their workforce.

Doing right by your client

To gauge whether the risk of misconduct has increased as a result of the pandemic, we asked respondents how likely it was that financial hardships in the financial industry would result in unethical actions on the part of the investment management industry. Some 45% of respondents globally and 50% in Asia Pacific thought it was likely or very likely.

We have not (yet) seen evidence of systemic misconduct, but the threat is very real — it’s a difficult and challenging time for the industry and for us as individuals. Right now, the need to build trust and professionalism is more important than ever. That means doing the right thing (even when no one is looking), treating our clients fairly, and building long-term, robust relationships.

By seizing the moment and demonstrating our worth, we as financial professionals can help the industry weather this crisis with its reputation intact, and with better outcomes for clients.

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