This article originally appeared in the Australian on 14 March 2020
Diversified portfolios comprise a mix of risky equities, defensive bonds and uncorrelated alternatives and cash that together could be keeping financial-year-to-date returns positive despite the recent share sell-off.
The sharemarket sell-off that started on February 24 has been fast and furious and reflects the belated realisation by both equity and bond markets that the coronavirus is exerting a supply and demand shock on the global economy and could spark a recession.
Monetary authorities and national governments responded quickly and decisively both here and overseas, but it was not enough to stem the sell-off.
So equity markets have remained in their corrected state and investors now wait to see if the correction will turn into a crash.
We understand the trigger of the collapse is the coronavirus, but none of us know exactly what happens next. We all need to get used to surprises being the new normal, whether it’s a virus or something else.
Whoever thought we would have interest rates at less than inflation? That long bond yields would be less than 1 per cent? And importantly, we need to practise our ability to respond and adapt to surprise thoughtfully, well and repeatedly without losing hope.
The core skill for the investor is no longer to stay the course but thoughtfully adapt.
I have recently needed to tell prospective clients that we cannot take them on when their strong wish is for hands-off portfolios that do not need to change and about which we do not need to meet regularly to rebalance. That is not how the world of financial markets is now and may not be for some time, if ever again.
So what should investors do?
- First – easy to say but harder to do – don’t panic. This is not a replay of the global financial crisis. The markets are not broken and investment products, by and large, are not broken. The particularities of the virus’s impact will hit some sectors and some securities harder than others. Conversely, some sectors and some securities could well benefit from the disease.
- Second, we need to remind ourselves of our objectives in investing. For many, the primary objective is an income of 3-5 per cent or it might be expressed as cash plus a margin or inflation plus a margin, or it might be as simple as $100,000 a year. Check how much you have made already this year and what your expected income is for the rest of the year. And then check for next year. In the face of any correction, are you still going to meet your income objective? You should now be more reassured. You will keep eating, paying the bills and be able to buy as much toilet paper as you like!
- Third, we usually also have a growth objective that is typically set at least at inflation so the purchasing power of our asset base remains intact. It’s usually expressed as inflation plus x, because we want the asset base to grow in line with the risk we are taking. But as we acknowledge that we are taking risk, we are accepting volatility in our investment portfolio and understanding that the growth objective is not going to be met every year. Most advisers when recommending an investment strategy seek their acknowledgment that there will be, for example, one year in six when there is a negative return. It is best to see the growth objective as a rolling objective over three to five years of, say, 3 or 4 per cent. And with financial-year returns where they are, it’s fair to assume that there may be no growth this year. That’s OK, we had massive growth last year — we just took a bit of an advance from this year’s returns.
- Fourth, this is a period that demands discipline — for implementing the same rigorous investment rebalancing we always do. We thoughtfully rebalance our portfolios back to agreed asset allocation. Market movements have caused new variations to arise from our target asset allocation. Pay attention to those variations. There is no need to act immediately, but we need to start work on what we need to do next when price targets are met. That means identify target purchases and target funding sources. We need to be prepared. Then we can look forward to possibly buying quality assets at smashed-up prices.
- Finally, this is the time for common sense. We have seen ridiculous consumer behaviour in response to the virus and will see more. Equally with investor behaviour. The news is likely to get worse before it gets better and the spread of the virus may worsen as weather in the southern hemisphere turns colder.
Ultimately, hope will return and markets will rebound. Stay informed and adaptable during the volatile times. Focus on your investment objectives, especially on income. Employ the discipline of slowly rebalancing your portfolios. Your portfolios will then come through this — and every — crisis in much better shape.
The fridge magnet now reads Keep Calm and Expect Surprises.
Sue Dahn is a partner at Pitcher Partners and was recently voted No 1 among Australia’s top financial planners in The List: Australia’s Top Financial Advisers.
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