Editor's note: Read the latest on how the coronavirus is rattling the markets and what you can do to navigate it.
First, let’s give voice to common wisdom. “The biggest error is to think that you can predict weather... and markets, warns Daniel Laverdière, senior director, expertise centre at Banque Nationale Private Wealth 1859. “A colleague was sure Trump’s election would send markets in a tailspin and bailed out, he continues. Well, markets exploded. Timing is the source of two erroneous decisions: when to get out, and when to come back in.”
Laverdière calls on history to remind us that catastrophes are a rather rare occurrence for a majority of investors. According to his market compilations going back to 1957, he observes that the worst 1-year period happened from July 1981 to July 1982, a period following the bubble burst during which the market tanked by -39.2%. “But people tend to forget that downfalls are followed by rises, he points out. The best single-year performance ever was the one that followed, from July 1982 to July 1983. The market went up more than double the fall by 87%.”
People also tend to forget how good things had been before the dip. Coming in second place in Laverdière’s compilation, the best two years ever are those that preceded that bubble bust, from March 1978 to March 1980, gains adding up to 54.6%.
What Laverdière also found is that the median investor still managed to make 10.45% in the record downfall that followed the blowout. So, one could conclude that downturns don’t necessarily turn out so bad.
Rebalancing recommended
Nevertheless, for those that would rather not sit tight, some things can be done to – hopefully -cushion the fall. Laverdière points to the positive effect of simple portfolio rebalancing. “The simple act of selling assets whose prices have become too high and buying at cheaper prices, especially when markets are down, can add about 0.4% of value,” he says.
An investor must ask a critical question: “What is causing the downturn?” suggests David Polak, equity investment director at Capital Group, to determine which investments can do well, and which can’t. His reading of the present situation is that two components are working together to pull down markets: the coronavirus is both a cause while acting as a detonator, in a market that was ripe for a correction. (The recent oil shock could contribute a third component).
Polak identifies the present situation as a “demand shock”. “People in cities will be doing less. They will travel less. They will go to restaurants less. So one should try to think of alternatives.” He sees at least three areas that could win: Internet companies (Amazon, Netflix, etc.), mobile payments and transportation. “There could be more remote meetings, he notes, people will consume more entertainment and there will be more home delivery.”
Another question to ask is: how far down can the market dip? “If you think that the market can fall by 20% rather than 10%, then it’s time to react,” Polak adds.
Apart from identifying stocks that may inevitably lose (air travel and tourist organizations) and those that will win, an investor can find refuge in asset categories that have a low correlation to equities. For example, REITS and infrastructure are such areas.
Corrado Russo, head of global real estate securities at Timbercreek Asset Management, shows that while not totally immune to market downturns, REITs as a category show resistance. “Since February 24, the MSCI global index has fallen by 9%, but the global REIT index (FTSE EPRA/Nareit Developed index) has fallen only by 6.8%”. According to research by Timbercreek, the correlation of global real estate to global equities is typically 0.78 (a perfect correlation is 1.0) while it is even better to global bonds: 0.63.
“The alternative”
A good place to find refuge is in “liquid alternative” funds, for example in the Picton Mahoney Fortified Multi-Strategy Alternative Fund, which presents itself both as a mutual fund and as an ETF (PFMS), or in the NBI Liquid Alternatives ETF (NALT) “We try to make a more robust job of building the betas of asset classes and adding strategies that are not directional, for example, equity market neutral, merger arbitrage, long-short credit, says Michael White, portfolio manager of the Picton Mahoney fund We tend to eliminate sensitivity to the direction of markets, but still generate returns.”
Such a fund that can short up to 50% of its assets is less vulnerable to market downturns. For example, in a strategy that buys long Coca-Cola and sells short Pepsi-Cola, an investor gains by the widening spread between both stocks, not by the movement of one or the other in markets.
The NBI fund has shown until now a resistance to the downfall (up to March 12), maintaining a positive level of 0.94% since the beginning of 2020, while the S&P/TSX and the S&P 500 have caved in by 25% and 22% respectively.
Investors who are heavily into mutual funds managed by large firms that hold dozens, even hundreds of funds, are in a better position to navigate through choppy waters compared to those who own individual stocks or ETFs. For example, inside the family of Fidelity or Mackenzie funds, an investor can move from, let’s say, an energy or an emerging market fund to a balanced or a REIT fund.
It is like jumping from a fast sinking ship to one that has better ballast. “An investor that has concluded that we’re down only 10% in a 20-30% fall, changing his portfolio to less risky positions is certainly a valid tactic,” says Polak, who adds: “Ultimately, the most important decision is to stay invested, not to be thrown off. Over the last 40 to 50 years, global equities have compounded at around 9%. Once you’re out, it’s always hard to get back in. You miss a lot of opportunities.”
And what if an investor holds a good amount of cash? Should they just hold on to it till the market hits what he perceives to be the bottom? Polak suggests to “average in” and not wait to invest it in one chunk. “Don’t try to time the perfect moment to go in, he advises. Break it up in a few pieces. You will probably never pick the bottom, but over time you will probably find good moments to jump in.”
