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4 | INVESTMENT EXECUTIVE NEWS May 2020 Economy should begin to recover this year, but progress will be slow
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peak in North America by early
May. For example, data released by the Ontario government on April 20 indicate that the rate of “community spread” in the prov- ince has probably peaked and is beginning to decline, although infection rates in long-term care facilities continue to grow.
In the U.S., modelling by the University of Washington’s Institute for Health Metrics and Evaluation (IHME) suggests that the peak of Covid-19 deaths occurred on April 15 and the death rate will level off by the end of May.
While these trends are posi- tive, economic activity is unlikely to revive immediately after the peaks. A report from Montreal- based National Bank Financial Inc. (NBF) analyzing the IHME data suggests that relaxing physical distancing require- ments may be possible in 26 U.S. states (representing about half of U.S. GDP) by the end of May, provided that testing capacity, contact tracing and crowd size restrictions are in effect.
“In other words, business is not getting back to normal anytime soon,” the NBF report states.
Toronto-based Toronto- Dominion Bank’s (TD) econom- ics division also is forecasting that the economy won’t begin to recover and GDP and job growth won’t pick up until June: “Rebooting the economy will
result in double-digit growth rates and a meaningful decline in unemployment in the second half of this year.”
The TD report also predicts that about half of the jobs lost in the first two quarters of 2020 will be regained in the third quarter, but GDP growth will not return to pre-pandemic levels until 2022.
A report from New York-based Morgan Stanley states the initial recovery represents the end of the beginning for the Covid-19 outbreak, not the beginning of the end. While the report also forecasts that the U.S. economy will begin to recover in mid- to late May, the process will take time.
That process will require “turning on and off various forms of social distancing and will only come to an end when vaccines are available, in the spring of 2021 at the earliest,” the Morgan Stanley report states.
The Morgan Stanley report adds that many workers won’t be able to get back on the job until “herd immunity” is achieved — that is, when about 60% of the population has developed resist- ance, either through vaccination or from surviving the disease.
In the meantime, restrictions will be needed to prevent a sec- ondary outbreak, including lim- iting large gatherings such as sporting events and concerts.
Given these expectations, the Morgan Stanley report forecasts a shallower rebound for the U.S., echoing the TD report’s forecast
that the economy won’t fully recover until 2022.
This slower recovery won’t happen to the same degree throughout the economy. Certain sectors will take longer than others to recover, and some may never fully recover. Others should be able to rebound rela- tively quickly, and may even enjoy stronger growth.
For example, the rapid shift to remote working is likely to stoke demand for increased telecom- muting capacity. The latest data from Statistics Canada indicate that about 40% of employees work from home now, up from slightly more than 10%. Online commerce and mobile financial services, which have been the fallback options for many busi- nesses in the midst of the shut- down, may be the beneficiaries of a permanent shift in consumer behaviour — at the expense of brick-and-mortar locations.
Economists anticipate sev- eral long-term structural chan- ges will arise from this episode.
“For starters, this pandemic will intensify three trends that were already growing in indus- trialized societies: telework, tele- medicine and virtual learning,” states the NBF report, adding that this shift will drive demand for related hardware and software and also could stoke demand for automation and robotics.
The NBF report also states that, at least in the short term, consumers will be more willing to give up some of their privacy
in exchange for more vigilant dis- ease prevention through grow- ing use of telehealth options: “[As with] surveillance technology, many people have shifted from worrying about the fast pace of automation eliminating jobs to viewing it as a must for disease prevention, at least for the time being.”
These forecasts of grow- ing demand for technology that enables physical distancing are echoed in a report from Toronto- based Bank of Montreal’s (BMO) capital markets division. In addition, the report forecasts other long-term effects, includ- ing shifts in supply chains (with increased emphasis on domes- tic manufacturing, particularly for critical medical supplies, drugs and other products) and swings in commercial real estate demand (away from office space and storefronts and toward ware- houses and logistics).
“The crisis, in some sense, has brought the future into the present, rapidly and sometimes harshly accelerating changes that were already in train,” the BMO report states. “There is no doubt that some sectors face long-term challenges as a result of the shutdowns and distan- cing measures, as well as some
potentially fundamental chan- ges in consumer behaviour and psychology. But at the same time, in classic creative destruction fashion, there will be some sec- tors that strengthen and step into the gap.”
Alongside the economic chan- ges, analysts anticipate macro effects from the pandemic.
A report from Toronto-based Bank of Nova Scotia’s economics division forecasts that the eco- nomic fallout is likely to leave the administration of U.S. presi- dent Donald Trump with the worst economic record for a U.S. president in the modern era (as measured by GDP performance) as well as middling stock market results.
The NBF report shared a sim- ilar sentiment: “Trump is facing difficult election prospects” in the wake of Covid-19.
The NBF report forecasts a variety of other effects on the U.S., including an increase in health-care spending, stock- piling of medical supplies and rising government deficits that may ultimately drive higher taxes.
“The impact of Covid-19 on the American landscape will long outlast the epidemic,” the NBF report concludes. IE
Investor advocates are concerned about unsuitable DSC fund sales
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market volatility and the intro-
duction of government restric- tions designed to curb the pandemic, the Canadian Se- curities Administrators (CSA) has taken steps designed to ease the pressure on investment firms.
Initially, these measures included extending filing dead- lines and prolonging policy con- sultations. More recently, the regulator took more meaning- ful action, such as delaying the implementation of provisions of the client-focused reforms and doubling the cap on mutual funds’ short-term borrowing from 5% of assets under manage- ment (AUM) to 10% to ensure that the funds can meet uni- tholders’ redemption demands.
The CSA is not alone. Regu- lators around the world are relaxing restrictions to support financial services firms. Yet, investor advocates are asking what regulators are doing to help alleviate the strains on investors.
Ermanno Pascutto, execu- tive director of the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada), says his organization has no issue with the steps that regulators are taking to provide relief for financial services firms and securities issuers. “However, we think [regulators] also need to consider relief for retail investors,” he says. “After all, the
purpose of securities legislation is investor protection rather than financial industry protection.”
FAIR Canada called on the industry to waive redemption fees on deferred sales charge (DSC) investment funds and pro- vide relief on investment loans for clients facing lost income due to the pandemic fallout.
So far, investment industry regulators are content to rely on the industry’s goodwill to deal with any cases of investor hardship.
Ken Kivenko, president of investor advocacy group Kenmar Associates, is particu- larly concerned about DSCs. He worries that the combination of financial pressure on the fund industry due to the mar- ket turmoil and the absence of hands-on compliance (thanks to physical distancing require- ments) pose an added risk of unsuitable sales.
In late April, Kenmar issued an investor alert that warned about DSC sales under the cur- rent conditions: “This is the ideal environment for hard-pressed fund dealers selling DSC mutual funds,” adding that these prod- ucts provide large upfront sales commissions to investment deal- ers’ reps, but come with an array of investor protection concerns — including that the DSC struc- ture creates significant conflicts of interest.
Most CSA members plan to outlaw DSC funds because of
such concerns. Ontario is the only province that plans to maintain DSCs, but it’s proposing a series of restrictions on their use — includ- ing that DSC funds can’t be sold to investors over 60 years of age, can’t be bought with borrowed money and can’t lock in unitholders for longer than three years.
Yet, for the time being, DSC funds still are available. Kenmar’s alert warns: “Given the troubled state of the mutual fund industry, amplified by Covid-19 related fund sales reductions and redemptions, the DSC fund, which provides an outsized quick payback, is the perfect product for fund salespersons in these challenging times.”
Furthermore, Kenmar’s alert suggests the current regulatory environment is only fuelling the risk of unsuitable sales.
“The pandemic-related relax- ation of regulations and internal controls and a regulatory ban of DSC funds that doesn’t come into effect until June 2022 creates a huge window of opportunity for hungry DSC salespersons to get their last crack at the DSC golden goose,” Kenmar’s alert states.
Pascutto agrees with Kivenko’s doubts about DSC funds and also raises concerns for retail investors who may have been using leverage when the market turmoil hit.
“We are concerned that retail investors who have taken out investment loans may have sus- tained losses of most of their
savings in the current market environment,” Pascutto says.
Another area of concern for FAIR Canada is group RESPs, which may have vulnerable investors locked into payment schedules that they now can’t afford.
To address that issue, Pascutto says, FAIR Canada will be asking regulators to “provide relief from penalties and forfeit- ures when people are unable to make scheduled payments.”
Yet, at this point, the CSA hasn’t done much that directly addresses the strains on retail investors. Instead, the regulator has focused on alleviating the obligations of firms in the invest- ment industry, with the expecta- tion that those policies will filter down to benefit investors.
For example, the CSA’s deci- sion to boost the ability of mutual funds to use short-term borrow- ing in order to meet redemptions doesn’t target investors directly, but does aim to ensure investors can redeem their fund holdings if needed.
The latest data from the Invest- ment Funds Institute of Canada indicate that redemption demand has been high since the pandemic took hold. Mutual funds collectively recorded $14.1 billion in net redemp- tions in March, with long-term funds reporting $18.2 billion in redemptions that month.
For context, this amount exceeds the redemption activity
at the height of the 2008-09 finan- cial crisis. In October 2008, mutual funds recorded $9.9 billion in redemptions ($7.9 billion in long- term funds and another $2 billion from money market funds).
Yet, back in October 2008, mutual funds had slightly more than $600 billion in AUM, compared with $1.45 trillion today. So, relative to industry assets, March’s fund redemption activity doesn’t look nearly as bad as that of October 2008.
However, redemption demand may have accelerated since then, as job losses have grown and eco- nomic prospects have become increasingly gloomy. The fact that the CSA was motivated to pro- vide funds with relief to facilitate redemptions in mid-April sug- gests that’s the case.
However, although the regu- lators have not yet taken action to directly aid investors, investor issues are on the regulators’ radar.
“Over the past few weeks, we have moved quickly to provide market participants with relief from certain regulatory require- ments, so [those companies] have capacity to focus on serv- ing the needs of investors,” says Ilana Kelemen, senior advisor, communications and stake- holder relations, with the CSA. “We are also considering actions to support investors and ensure they are treated fairly during this difficult time.” IE
Many workers won’t be able to get back on the job until “herd immunity” is achieved