Financial Times Europe - 20.03.2020

10 ★ FINANCIAL TIMES Friday 20 March 2020

Not all liquidity is created equal in the

world of exchange traded funds, the

low-cost, largely passive funds

favoured by US investors. The

coronavirus pandemic has driven a

wedge between equity and bond ETFs.

This has sometimes been in some big

gaps between share prices and the

value of underlying assets — sometimes

called “the delta”.

Amid wild swings in securities and

oil prices, ETF trading volume hit a

record $1.4tn last week. This accounted

for nearly 40 per cent of all equities

trading on US exchanges, according to

ETF group iShares.

The sell-off in equity ETFs has been

largely orderly. The price of the $227bn

SPDR, which tracks the S&P 500 index,

dropped just 0.13 per cent below its net

asset value on March 12. The second-

biggest ETF, the $164bn iShares Core

S&P 500 fund, ended Thursday of last

week with a slim 0.14 per cent discount.

Compare this to fixed-income ETFs,

many of which are trading at steep

discounts to net asset values.

Vanguard’s $55bn total bond market

ETF saw its delta surge to a 6.2 per cent

discount on March 12. Sellers lost out

by that much, on paper at least

For critics, big discounts are proof

that ETFs — baskets of securities each

of which trades via a quoted share —

create an “illusion of liquidity”. They

allow investors to trade in previously

illiquid parts of the market. But

liquidity can vanish during a

meltdown.

ETF providers counter that they

make it easier for investors to escape

less active markets in times of distress.

This misses the point. ETFs are only

liquid because market makers trade to

minimise the delta. Without them, the

system breaks down. In current

volatile markets, where huge asset

classes can become briefly illiquid,

some of these middlemen have been

opting to stay on the sidelines rather

than cash in on arbitrage

ETFs:

delta blues

opportunities. If dislocation of the kind

seen in US Treasuries recurs, ETFs are

certain to show further strains.

In 1914, the UK was so underprepared

for war that new recruits marched in

mismatched clothes. Dye used to

colour British Army khaki uniforms

was imported from Germany. The UK

was forced to manufacture its own. As

with chemicals then, so with medical

ventilators now.

These devices are essential for

treating victims of coronavirus.

Unsurprisingly, there is a global

shortage. Penlon and Breas, two

Ventilators/UK industry:

command performance

companies that manufacture in the

UK, cannot cover demand. More than

20,000 may be needed shortly. The

National Health Service has 5,000.

Prime minister Boris Johnson wants

business to start building ventilators

from scratch. Three consortiums led by

aerospace supplier Meggitt, carmaker

Nissan and engineer McLaren aim to

make 35,000 units.

The project has started badly, with

quibbling over regulatory obstacles and

design. The fault is Mr Johnson’s. His

hero, Britain’s wartime leader Winston

Churchill, would simply have told the

companies what to do. If the law

precludes rapid deployment of a new

ventilator, the law will have to be

changed. Copying an existing design at

a take-it-or-leave-it royalty is a parallel

solution. Free marketers, Lex included,

flinch at a return to a wartime

command economy, however brief. But

markets are not sacrosanct. They are

just mechanisms that may be freed or

curbed to allocate resources.

It makes sense for Mr Johnson to

choose a design via a quick competitive

tender. The winner would then

subcontract segments, with heavy-

handed help from government where

required. This was how ships, tanks

and aircraft were made, fast and in

volume during the second world war.

Manufacturers are not currently in

great shape. The FTSE 350 industrials

index is down 30 per cent since the

start of March. No government should

commandeer the assets of the private

sector, except in an emergency.

An epidemic that has killed 9,

people surely qualifies as one.

This era of work from home will leave

us all with regrets. Wearing that rock

band T-shirt for a video conference.

Eating cold pizza for breakfast. For US

hedge fund starBill Ackman, it will

probably be a CNBC TV interview.

After proposing a 30-day “spring

break” for America, Mr Ackman

asserted the private equity industry

would go “bankrupt”, citing Blackstone

portfolio companies, as one example,

as vulnerable. He felt abashed enough

to then apologise to the business.

Mr Ackman apparently invested in

the company, whose shares are down

over a quarter. The pandemic will be

the second ugly dislocation Blackstone

will experience as a public company. If

itisanythinglike the first, Mr Ackman’s

prophecy of doom is misplaced.

Blackstone listed its shares for $31 in

2007. They fell to just $4 during the
      financial crisis. Yet unlike big banks,
      private equity managers had virtually
      no leverage on their balance sheets.
      The combination of locked-up investor
      capital and bargain-buying chances
      proved unstoppable.
      This year, Blackstone’s shares topped
      outabove$60. It had paid $20 per share
      in total dividends over the years. In
      2019, Blackstone earned more than
      $3bn of management fees, a stream
      that will persist. That scenario could
      play out again. Blackstone has $150bn
      in dry powder across its private equity
      credit and real estate groups. There will
      be pressure to recapitalise businesses,
      forestalling liquidations and saving
      jobs. Even if debt markets are not
      hospitable, assets may be so cheap that
      all-equity deals will be lucrative.
      Mr Ackman may have a point about
      struggling companies that buyout
      groups own. But if the economy
      recovers quickly and the government
      keeps pumping money into the system,
      there is the chance of a rapid snapback.
      Regardless, expect private equity to
      do just fine. Plenty of ready capital,
      ultra-cheap valuations and the
      willingness to be patient form a potent
      combination. Mr Ackman may one day
      appear on TV to explain it.

Private equity/Ackman:

Blackstone’s spring break

The European Central Bank’s
emergency bond-buying programme is
a tremendous kick that sends the can
skittering down the road. The risk of a
credit crisis has been averted —
temporarily. The fall in eurozone bond
yields is a relief rally that will not last.
Blame Italy. Everyone else does.
Before the ECB announced its bond-
buying plan, the country’s borrowing
costs were soaring. The gap between
bond yields in Italy and Germany had
widened — an acknowledgment of
realistic differences in country credit
risks amid the coronavirus outbreak.
Italy now has more than €2tn in
public debt — equal to nearly 135 per
cent of its GDP. German debt is at 62
per cent of economic output. Italy has
never relinquished the original sin of
the last financial crisis. Domestic banks
and sovereign debt remain entwined.
The ECB’s €750bn Pandemic
Emergency Purchase Programme has
done the job for now, spurring a rally in
stocks and bonds. The spread between
Italian and German 10-year bond
yields fell from 253 basis points on
Wednesday to 190 basis points
yesterday. Backslapping all round.
ECB president Christine Lagarde
claimed earlier this month that it was
not the central bank’s job to narrow
sovereign spreads. But the ECB had to
try. Italy can ill-afford high borrowing
costs in the midst of a crisis. Its
rightwing politicians already bristle
against eurozone membership. A
messy exit raises the spectre of a vast
sovereign debt default.
The ECB’s decision to make its bond-
buying programme “flexible” is also
the right move. Expanding eligible
assets and raising the possibility of an
end to debt purchase quotas shows
commitment. Ms Lagarde’s claim that
“there’s no limit” to the ECB’s support
of the euro is designed to sound like
predecessor Mario Draghi’s effective
“whatever it takes” motto to support
the eurozone in the last financial crisis.
et the market effects of ECB, Bank of
England and Federal Reserve support
may be short lived. Cash will remain
alluring. Low interest rates and asset
purchases were already in place.
Central banks have upped the ante, not
changed the game.
Without a clearer timeline for the

ECB/bonds:

a hiatus, not a reprieve

attenuation of the pandemic,

conventional investment is impossible.

There is no signal, only noise. The

ECB’s existential question remains

unanswered: does Europe have the

stomach for Italy’s debt burden?

CROSSWORD

No. 16,430 Set by ALBERICH

 



 

 

 

 



 

  

 

 

JOTTER PAD

ACROSS

1 Rescue vessel wrecked on a hot

island (5,3)

5 Wrongdoing linked with a

former war zone (6)

10 Blunt fatty shortened belt (7)

11 Reasonable description of diet

food impresses soldier (7)

12 Revolutionary heading from

Leicester Square returns (5)

13 Rich adult forming relationships

around university (9)

14 Advantage having husband in

prison? It strikes a heavy blow

(12)

18 Move corn or oat – tip for good

farming practice? (4,8)

21 European character breaks

engagement for show (9)

23 Meat that’s raw changing hands

(5)

24 More than one jolly complicated

seminar (7)

25 He would possess

overwhelming love for dance (7)

26 A kid is relaxed (2,4)

27 Advocates having porters

perhaps outside station (8)

DOWN

1 Aristocrat pens book revealing

bribe (6)

2 Literary lion takes time on a

slope (6)

3 Star, not a person who could

catch sole killer (9)

4 A CD, Sir Arthur Bliss’s last

works, inspiring second

composer (7,7)

6 Half-hearted scolder upset

king’s daughter (5)

7 Losing two pounds, Malcolm

worried about his virility (8)

8 Totally grisly, gripping end to

macabre tale (8)

9 Overworked retailer may be so

disorganised (3,4,3,4)

15 A jackass brought up point,

displaying hauteur (9)

16 A media broadcast covering

California’s scholarly world (8)

17 Politician with minister to

protect (8)

19 Supply new equipment and

thief turns up (6)

20 D Washington’s co-star in

Philadelphia cheers (6)

22 Class brainbox lacks ego (5)

632.(1 /$0%$67(

( 9 9 & 9 $ ( ;

7+(5()25( 121(

$ 5 5 9 5 ' 6 (

6262 *(7$029(

, , 3 5 * / '

'2*7527 (9,1&(

( + 2 ( 2 '

67,)/( 675$1*(

6 / 3 4 6 6 &

/$6&,9,286 129$

, 2 * 7 $ 0 1 '

9,//$2%67,1$7(

( , 7 0 + 1 1 1

5('((0(' %($7 , 7

Solution 16,

Lexontheweb

For notes on today’s breaking

stories go towww.ft.com/lex

Twitter:@FTLex

Next’s brainy boss sums up the state

of retailing with welcome clarity.

People do not buy a new outfit to stay

at home,Simon Wolfsonsaid. What

startedas a supply shock has turned

into a collapse in demand. A

statement from the UK fashion

group, with the latest full-year

results, was equally stark.

Investors have responded to the

crisis by dumping Next’s shares as

quickly as trendsetters spurning last

year’s threads.

Their value slumped 46 per cent,

or £4bn, in the month to Wednesday.

That is worse, by far, than the FTSE

100, down less than a third.

Covid-19 uncertainties have sapped

investors’ morale. So the shares

bounced about 7 per cent on the

release of a stress test. This showed

how the retailer’s finances would be

affected by the loss of between a tenth

and a quarter of its annual sales. It

assumes some savings from cancelling

orders, stopping overtime and not

replacing staff who leave.

The middle path, a 20 per cent fall in

annual sales, might see a cash shortfall

of £245m in August, when financing

needs peak. That might breach

covenants, if Next had not asked banks

for headroom.

There is a lot Next can do to preserve

cash, meanwhile. Cancelling buybacks,

which cost £300m last year, is a no

brainer. Delaying capital expenditure

and selling a warehouse are also

options. Scrapping dividends to retain

£220m would be the last resort.

Next could therefore end the year

with reserves of £835m, even after a

20 per cent fall in sales. It is in talks

with its banks to increase facilities by

£200m. It does not expect to tap

government coffers.

If it kept the dividend, the shares

would be supported by a yield of

some 4 per cent. But even if Next cuts

the payout, the fall in the share price

would be excessive. The outbreak

might cost some £500m-£1bn of cash

flows this year and next. That hardly

justifies a £4bn slump in market

value. Fears of collapse must be the

reason. Investors should now feel

reassured on that score.

Next has set a pattern for

epidemic-era disclosure that other

businesses should follow.

Next net debt and financing plan prior to coronavirus

£bn, 2020

1.

1.

1.

1.

1.

Net debt; base case

Cash resources Headroom at peak £210m Headroom at year

end £390m

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

1.

1.

1.

1.

1.

Cash resources Shortfall

£245m

Net debt: if sales fall 20%

£bn, 2020

Next financing projection without mitigation

Share prices

Rebased

Sources: Company Refinitiv

50

60

70

80

90

100

110

Feb (^2020) Mar
Next

FTSE 100

Next/Wolfson: more wary quant than Mary Quant

Retail group Next has assessed the financial squeeze it faces if Covid-19 hits annual sales by as much as a

quarter. Its stress tests suggest a £245m shortfall in cash resources in August if sales fell by a fifth and there

were no mitigating action. That contrasts with earlier expectations of £210m headroom in August.