In October last year, Jerome Lander wrote a wire titled "How to invest productively in the coming recession we have to have".
At the time, equity markets were finishing off one of their best years in a long time, and the economy was trundling along, so the wire may have seemed overly bearish at the time. Yet Jerome wrote that:
"A recession affecting even the ‘greatest’ economy of them all is probably right in front of us. As a result, how investors position their portfolios this coming quarter and in 2020 may be all that matters."
On the 24th Feb, just as the equity market was at the precipice of a fall that has by now taken a full 1/3 off the value of the ASX200, Jerome then published a follow-up wire, A call for action to prevent you being Coronered, urgently warning that:
Contrary to market consensus – the coronavirus (COVID-19) is actually a real threat to complacent equity markets and client portfolios. It is a global health pandemic which requires active management in the real world, and which should also be risk managed by your adviser or super fund. The coronavirus and its real-world management should not simply be dismissed as just another flu, and could even be the catalyst which bursts the global asset bubble.
The US is now staring down the barrel of a recession, volatility is extreme and investors are scrambling to position their portfolios appropriately.
Jerome Lander is Managing Director of boutique investment firm Procapital and outcome-based managed account portfolios with Dynamic Asset. He is also the portfolio manager of the Lucerne Alternative Investments Fund with Lucerne Investment Partners.
I reached out to him yesterday to get his view on what the road ahead looks like from here, asking him:
- Can you summarise the Australian economic status quo as you see it today?
- How were you positioned going into this, and how well did it work?
- What do you expect from the economy and markets for the rest of 2020?
- Outline your asset allocation if you were building a new portfolio today.
- Investors should take a dynamic asset allocation approach because "...
- What other icebergs lay up ahead that no one is talking about..?
Read on to hear his extensive responses in full. Thanks to Jerome for his quick responses during a very eventful week in markets.
Q: Jerome, can you summarise the Australian economic status quo as you see it today?
The Australian economy is likely already in a recession. Many of our export industries including education and tourism are devastated and presumably will be until we get through this. We are very interested in the ongoing government and societal responses to this crisis, as they will determine how long this crisis lasts. It is important to recognise that an effective public policy and medical response is required and that central banks can’t solve this crisis, but can only help mitigate some of the short term damage while potentially creating further medium-term problems.
We gradually appear to be responding more appropriately but still not effectively, after having dropped the ball entirely to begin with. Our slow and in my view entirely inadequate response has resulted in significantly more economic and health damage than would otherwise have been the case and significantly more people will probably die or be very ill as a result. It was avoidable as policymakers could have taken a lead from overseas and the seriousness with which those best able to assess the threat - China - was taking the coronavirus threat in January.
We have been offered a roadmap from the response of more effective governments in Asia more broadly. Given the unprecedented public health threat, I wish we had have quarantined or even stopped inbound travel early to assess the nature of the threat properly, and potentially enable us to more effectively manage, contain or avoid the size of the problem we have now.
We are paying dearly for our lack of an optimal response to this crisis. In one way, although no one is going to feel like that, we are incredibly lucky the coronavirus isn’t substantially more deadly or our decisions – combined with our ineptitude - could have cost us a truly unimaginable and horrific amount of lives. The cost still risks being enormous and profound because of the nature of the virus, and the ineffective early and ongoing risk management of this issue, just as it will be for many other countries who have responded as poorly or even more poorly.
As well as hoping we improve our public policy response, we’re hoping and looking for definitive signs of drug trial success. For example, if we are definitively able to treat the coronavirus more effectively medically than we can at the moment, that will be an enormously important step as it will reduce the load on our hospitals and provide some confidence to markets. But to be clear, we currently have to rely on public policy measures such as aggressive testing, quarantine and social distancing to get through this crisis most effectively.
Q: How were you positioned going into this, and how well did it work?
We selectively advise and manage on a few different portfolios with a very select client base, which have variable management depending upon their objectives and opportunity set. I am very conscious and focused on risks currently – as I believe we all should be - and was very early to predict that what has happened could happen as laid out in this wire.
I shared these concerns widely just before the market fell apart, warning that many were about to get “imminently coronered” even when warned.
This demonstrates the benefit of an active and risk-aware approach versus a “hold and pretend” strategy. Our clients all benefitted compared with what would have been the case otherwise, and some of them tremendously so. There is no doubt most investors were massively long going into this crisis and almost completely oblivious to any risk, with the prior narrative entirely about central banks boosting the markets. I even made my underlying fund managers my clients invest with aware of what this pandemic could do.
I also shared my concerns publicly and with public health officials and other influencers to try and help them prevent what was otherwise coming. I have been surprised and disappointed by the slow and often times inadequate responses from many parties. I spent valuable time trying to help everyone while simultaneously trying to assess what was happening. I still am, as the future remains quite unclear and binary in nature in the short-term from the point of view of markets.”
We learnt again through this exercise how poorly most super funds and advisers are set up to best meet clients’ interests, even when something is presented to them on a platter. This crisis has simply shown that many people are simply good talkers who never spend any of their own time assessing and managing risk in the interest of their clients and really don’t think too hard or are curious enough about the world. Their models for managing money are deeply flawed. They promote fictions such as price and risk insensitive buying as being suitable all the time (index or passive investing) and strategic asset allocation based on always having the same backward looking portfolio regardless of valuations or forward looking risks.
Many people assume that equities and property will always go up, and that you should buy any dip in price. This is simply untrue and incredibly dangerous and naïve, as it is quite possible that this will not be the case. The same advisers also assume that owning bonds will always cushion their equities risk, which has been the case for so many years, but will probably not be the case from now on.
As an industry, we hence need to think very differently about how to manage money and stop telling clients falsehoods and stories, and pretending we know something when we are deeply ignorant and the environment is so different and difficult to manage. We should assume we don’t know much about anything at all (because most of us really don’t), and instead try and manage risk and identify opportunity thoughtfully. The world may be very different coming out of this crisis than before and will be highly challenging to those who can’t adapt their stance.
By way of positive example, The Lucerne Alternative Investments Fund (LAIF) is a non-traditional and active portfolio I run with the ability to invest in high-quality wholesale funds and combine them in a forward looking manner to keep overall portfolio risk low.
This fund has held its entire value in a consistent way through the market collapse and it is on track to meet its high single digits targeted returns since 1 July 2019, when I took over management of the fund, notwithstanding the unprecedented crisis we have seen.
It is designed to be resilient and diversified, and we have positioned it aware of the likelihood that a crisis and a recession was a high risk, as this was my assessment. Indeed, a pandemic was one of the “x-factor” risks I previously identified that could end the bull market.
LAIF is a multi-asset multi-manager strategy which is designed to make absolute returns which are better than likely returns from traditional portfolios, but with much lower risk. It targets investors who recognise that traditional ways of managing money may not get you the results you want or take you on a journey which you can tolerate.
From late January, we warned clients that risk was being underappreciated and that coronavirus could be the catalyst for bursting the massive asset price bubble that has been built up in recent years. I have written numerous previous articles on the bubble in asset prices and the risk of recession. I am not the only person who has done this.
The more traditional portfolios I run have also performed better than the typical traditional portfolios. We raised cash to the highest ever levels they have ever had but remain wary of the policy response and uncertain nature of these markets. These are unquestionably difficult to navigate now we are “in the poo” that central banks and our massive capital misallocations have kindly created for us.
While some of these portfolios have done exceptionally well, others have not quite performed to our high standards given their precious metals risk exposures were used as a source of liquidity by the broader market deleveraging. We expect this situation will change significantly over the rest of this year as the massive monetary and fiscal response may prove very supportive for certain assets.
We work with our clients to make decisions that are suitable for them. One of our clients decided to sell out of their large Australian equities portfolio in their entirety to avoid the risk we outlined. Needless to say, their clients are pretty happy about that and it will hopefully help them grow their business to get the success they deserve. I expect that in future they will allocate more money to carefully chosen liquid alternatives to avoid the likely rollercoaster in equities, particularly given their ageing client base.
What do you expect from the economy and markets for the rest of 2020?
We are most likely in a bear market and probably need to pay back most or all the huge excesses of recent years, which will be very painful. We are coming out of an era of fake wealth, where everyone has thought they are richer than they really are, simply because we’ve boosted asset prices to unsustainable levels and continue trying to do so.
Real wealth isn’t built by central banks artificially boosting market prices, socialising losses, promoting zombified corporations, or companies buying back their own shares to enrich their management. Without real productivity gains and good leadership and management, there is little reason to expect substantial sustainable gains in the long run from high asset price levels, even if it appears to work over shorter time periods.
Some wish that were not the case because wouldn’t that be a nice fairy tale, but given it is, I believe active and dynamic management of risk and opportunity is essential to best meet client objectives. The financial services industry more broadly needs to help facilitate better capital allocation.
Governments need to stop pretending that printing money and socialising risk can make us all rich. We need to stop promoting and allocating excess capital to unproductive asset classes such as residential property, and instead build real wealth through productive enterprise and excellent operational and risk management.
Unfortunately, many illiquid property, infrastructure and private equity asset classes will probably eventually be marked down as they follow the values of their public brethren. While we are punishing good capital allocation and rewarding poor capital allocation through massive market distortions, we can expect to do more poorly as a society than we would otherwise
Outline your asset allocation if you were building a new portfolio today
This really varies depending upon the client objectives, time frame and risk tolerance. However, for some investors, I would suggest something as outrageous as a 70/30 portfolio. 70% in liquid relatively market neutral alternatives, and 30% in everything else opportunistically.
I don’t think 100% cash is a good idea. We don’t have a crystal ball and current monetary and fiscal policies will probably prove enormously damaging to cash over time, as well as everything else.
But I do like the “cash +” portfolio or a portfolio of carefully selected alternatives run by specialist strategies that are combined and managed in a skilful way to produce an absolute return with high probability and low market dependency, which is what many people actually want for their money.
I’d prefer to only opportunistically add to asset classes such as equities rather than risk all my clients’ future on a majority allocation to them, and I don’t believe that most clients can tolerate the risks that a majority weighting to equities involves.
In other words, I’d suggest that what the average large super fund or adviser does at the moment is most probably the complete opposite of what you should be doing if you had greater flexibility and capability, understood the market’s risks and opportunities, and truly stood up for what was in your clients’ interests.
That said, there are many ways to achieve a result and I nor anybody else has a monopoly on them. However, late February and March is shaping up to clearly demonstrate to everyone that the risks they are taking currently may not be the risks that they can tolerate or want to be taking with their current approach.
If so, investors should look to adjust accordingly with expert advice, and find the right alignment for them that they can live with. Investors shouldn’t pretend that everything will go back to normal, because what we have seen in the last few years wasn’t normal and nor is it sustainable. There is an alternative to equities, and it is genuinely active and thoughtful investment management.
Please complete this sentence - Investors should take a dynamic asset allocation approach because...
Investors should take a dynamic asset allocation approach because market opportunities and risk are not static; they change regularly and very substantively.
The coronavirus crisis is an example. It was foreseeable. The impact has certainly turned out worse than it would have with better management of the risks on the part of governments worldwide, but not to have seen it at all is fairly clear evidence of complacency and lack of interest and curiosity about the real world.
To have seen it and not done anything at all about it, as the traditional strategic asset allocation approach run by your super fund and adviser has probably done, is fairly clear evidence of why a more dynamic and active risk management process is needed. The truth is that avoiding catastrophic losses is crucially important to achieving strong long term investment results for clients due to the impact on compounding.
No one can say that equities won’t lose 50 or 60% or more from recent peak values, nor that they will. But the fact that they can and that they can do it very quickly in today’s world, should demand a better way of managing money.
Clients deserve better management of their life savings and a journey that they can live with. They need a more dynamic approach, even if it means their investment partner has to be work harder at being different, and they have to pay something for that.
It is a great fallacy that you can get a great result for free and that giving your money to Wall Street will result in a good outcome; that simply reflects a time that has now passed its use-by date.
What is the next iceberg that we hit that no one is talking about..?
There are lots of them unfortunately and somewhere someone is probably talking about some of them.
Eight potential icebergs readers may not have thought about include:
- Other frozen funds such as direct property funds and some private debt funds.
- Falling property markets as Australia enters recession and job losses climb.
- The collapse of the high yield market as the massive amount of inappropriately rated low investment-grade debt is re-rated, defaults climb or soar notwithstanding government support, and high yield ETFs are hit with massive retail redemptions which they can’t meet given the underlying illiquidity of their assets.
- De-globalisation and the risk of stagflation.
- The risk that the coming recession is a depression that makes even the bears look like they were hopelessly optimistic.
- The risk of war and greater geopolitical conflict as leaders look to turn their electorate’s focus elsewhere.
- False valuations for illiquid property, infrastructure and private equity assets in large super funds resulting in frozen assets and inability of slow to react clients to get out. Furthermore, due to lagged valuations, some super funds may report unrealistic performance this month that doesn’t reflect real world valuations if they were to sell their assets on the open market.
- The risk of widespread retail redemptions in response to the dreadful performances many super funds and investment managers look likely to report from March’s market collapse, assuming there is not a miraculous recovery by month end.
Of course, I’m personally hoping for effective treatments, vaccines, and public policy measures and that the developed world miraculously carries on pretending we can get rich with no effort or skill, and do it without paying any fees to anyone. Aren’t you?
Jerome Lander is Managing Director of boutique investment firm Procapital and outcome-based managed account portfolios with Dynamic Asset. He is the portfolio manager of the Lucerne Alternative Investments Fund with Lucerne Investment Partners
Thanks Alex/Jerome, great article. If the ship hits icebergs 4-6 it will be titanic-like; lifeboats in shortage (active managers), people laying in beds below while the water rises (superfunds and passive investors) but also many just swimming directionless in the freezing cold (individual investors). Gold is stagnating...why? everyone still thinks they are going to be the shark that capitalises on this 1 in a 100y "opportunity". 4-6 will bring on the real gold rush? $2800 in 2-3 months.
As an amateur investor with my personal wealth at stake, I am pleased I was only 50% invested mainly due to my gut telling me that we were already on the handcart to hell. I have already become very tempted by the prices of a number of stocks, but this article by Jerome has reined in my enthusiasm and convinced me to wait . I think I need to see a worldwide reduction in the number of Covid19 cases as well as a confirmed medical solution and millions heading back to a paid work environment and spending again. Maybe then I'll invest my limited $$ Rob Chandler 22/03/20
A great article and I have worried for some time about the valuation of unlisted assets in superfunds. This alone made me move to conservative options. But the tone of the article is a little bit smug imho.
I've been 85% in Cash & Fixed Interest since 2016. Why that long? Because the market has been over-leveraged that long (longer, actually) and I'd much rather have got my +0-4% yearly in the interim 4 years, than being exposed to perhaps 40%+ losses coming up right now. As I get back in at the bottom (or at least, a long way from the top), Jerome's take on the whole economy matches my thoughts exactly. I'm thinking a 15-20% allocation through my employer Super fund - does the Lucerne Alternative Investments Fund allow that kind of entry, and if so, through which industry Super Fund?
Well presented Alex and Jerome I think the signals were well and truly there that something was amiss in early Jan this year and the market wasn't the place to be for the retail investor. I think the ultimate point of clarification was the placement of a single 4million USD bet for rising volatility (VIX )on 9 Jan by a hedge fund Manager. Going forward with the US fed administering copious amounts of medication to buy time there will be a consequence to this later on . Certainly the 8 points raised in the 'Iceberg" are valid, however there will be other 'knock ons' that are yet to be identified by the markets .Whilst there will be some amazing opportunities for investors a little further down the track there will be a lot of people left in a world of hurt as a consequence of this insidious disease. Hopefully a solution will be identified sooner rather than later.
The horse has bolted, the article reiterates the bleeding obvious., telling noth8ng we don’t already know, unfortunately
Great article that should spur debate on our future course. At the end of the turmoil a well thought out discussion on what is value / valuable is needed. Endlessly skyrocketing residential property is politically popular, but useless if not detrimental to society. Low interest rates are a big factor which propped up lots if unproductive asset classes resulting is faux wealth. Time to deleverage and bring back creative destruction
Thanks for making the time to make comments on this article. Jon, if desired, you can contact me or Anthony Murphy, CEO of Lucerne Investment Partners for further details about LAIF. The coronavirus infection is frightening and threatening to both our health and our economy, and not just to the elderly or those with pre-existing health conditions. There is hence absolutely nothing for anyone to feel smug or complacent about given where we are today; that would be utter foolishness. I am certainly not feeling that way, and have tried to warn others to stop being so complacent about this issue, which has only deteriorated with time.
As an amateur investor, my gut feel is to wait till at least the global infection rate starts to plateau at a minimum before I start to dip my toe in again.
I'm thinking a good point to buy back in will be when the market is down 89%
Another good time to buy back in might be when amateur investors (like me) are not reading livewire anymore.
Great article Alex. Jerome sounds like a prophet in these times of great medical and financial chaos/upheaval.