Global equities Q&A: Will COVID-19 reshape the structure of global business?

In his bestselling study of economic globalisation, The World is Flat (2007), Thomas Friedman described a visit to an auto-parts manufacturer in China. On a sign hanging over the factory floor was a proverb, translated into Mandarin:

“Every morning in Africa, a gazelle wakes up: it knows it must run faster than the fastest lion or it will be killed. Every morning in Africa, a lion wakes up: it knows it must outrun the slowest gazelle or it will starve to death. It doesn’t matter whether you are a lion or a gazelle; when the sun comes up you better start running.”¹

This Darwinian take on competition is worth pondering in 2020, as the coronavirus pandemic disrupts industries across the world. Speed is of the essence: companies are having to closely monitor the impact of the crisis and adapt quickly to stay ahead of their rivals.

But the pandemic may also be leading to deeper changes in the kind of globalised business models Friedman documented in his book. By drawing attention to vulnerabilities in supply chains, the crisis has prompted some international companies to begin prioritising inventory-building resilience over streamlined efficiency, at least in the short term.

In this Q&A, Mikhail Zverev, Aviva Investors’ head of global equities, assesses the impact of the coronavirus pandemic across industries and cross-border supply chains.

What qualities make companies resilient during a crisis?

You need to ask the question: “resilient to what?” Like “quality”, “resilience” may sound like an absolute concept, but it depends on context. Whether the risk is a theoretical black swan or a clear and present danger, investors need to look at a company’s capacity to respond and adapt to change.

It's also important to remember pandemics don’t come along every day. If equity investors only select companies that look safe under all conditions, they will miss opportunities. Assessing resilience is about taking a view on the fundamental characteristics of a business, what’s changing in that business, and what is already priced in.

You always need to think about resilience in the context of change. Change works both ways; it can be an opportunity and a threat. This is because change creates inefficiency. When something is changing in a business, when the future isn’t equal to the past, the market is more likely to misunderstand and misprice it, because when investors can’t continue to extrapolate from the past, they have to work harder to connect the dots.

What changes are you seeing in the current crisis?

Some changes will be positive for certain businesses: for example, more working from home will mean some tech companies benefit to a degree that isn’t always priced in. Some business models that were relevant before are even more relevant now due to shifts in consumer behaviour. For example, the crisis will accelerate the transition from cash to electronic payments and the transition from offline to online commerce.

Are any other COVID-19-related changes being overlooked by the market?

What is happening to the car industry is interesting. The industry has been challenged on many fronts, such as shared mobility and the growth in public transport in urban environments; incentivised and supported by government measures to decarbonise the economy. But in this crisis, a car has suddenly become a very valuable and relevant thing for a family to own, because people want the option of a safe, non-public mode of transport.

Is there evidence of increasing use of cars?

One striking statistic coming out of China, one of the first countries to emerge from lockdown, is that driving in cities is increasing. Judging by the metrics available, like the number of cars on a highway on a given day, car traffic is 20-25 per cent higher now than the average for 2019. By contrast, use of public transport, like subways, trains and local flights, is still 50-60 per cent below pre-crisis levels. So there is a clear shift to individual transport by car.

The car industry stands out, because many would have thought it would be a relative loser in the recent crisis; it’s a cyclical industry with lots of structural problems. The markets still aren’t pricing in any benefit to the industry from the COVID-19 pandemic – but the data coming out of China suggests there may be one.

The crisis has illustrated the tiny margins for error or delay built into global supply chains. Will this cause a lasting change in how supply chains are run?

There is some evidence of a shift from “just in time” towards “just in case” models in global supply chains. The phrase “inventory is king” is also being used on the front lines of global business.

In the technology supply sector, companies are expecting the world to return to a degree of normality at some point; the crisis may even boost demand for consumer electronics such as smartphones by highlighting the importance of being connected during a lockdown. Companies that supply these devices are taking the view that if demand returns to normal – at a time when highly complex supply chains are still liable to malfunction – they need to build inventory.

Take the semiconductor sector. Before the crisis, a large inventory was a sign of falling demand for a product; now it’s a sign companies are preparing for demand to come back. This may be a transitory phenomenon, but it’s an interesting development investors should keep an eye on.

Could we see more reshoring of supply chains?

Two recent events – the trade war between the US and China, which is far from over, and this pandemic -have reminded people global supply chains are not always reliable.

Consider active pharmaceutical ingredients, or APIs, which are predominantly manufactured in China. The ongoing geopolitical uncertainty, coupled with the fact the pandemic has illustrated how crucial healthcare supplies are to the normal functioning of society, has led to debate about whether that industry should be reshored. Anecdotal evidence suggests reshoring of supplies of pharmaceutical ingredients may have already begun.

Has this crisis caused you to think differently about your investment approach?

The crisis has emphasised that being responsive to change is more relevant than ever. It also shows that, when a crisis is affecting multiple regions, sectors and assets at the same time, it is extremely helpful to be able to cooperate with colleagues across geographies and asset classes.

At the beginning of the crisis, many companies were rushing to tap the credit markets to build liquidity; company management teams were not speaking to shareholders as much during this “firefighting” period. By collaborating with colleagues in the credit team, we were able to get a sense of how the crisis was affecting those businesses. This sort of connected thinking is always useful, but particularly so during a crisis.