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How to invest productively in the coming recession we have to have

Jerome Lander


(Ed note: first published October 2019): By now, the situation is clear. Many economies are gradually slowing down or have already entered a recession (think European powerhouse “Germany”). 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.

Central banks can’t save major developed nations from entering recession. You only need to listen to central bank policy makers to hear them now effectively admitting that they’re pushing on a string. They don’t control economic growth, and are effectively begging other arms of (seemingly deaf) governments to rethink their policies, provide fiscal stimulus and structurally reform.

Central bank policy has prolonged the inevitable but has only really been effective at creating an “Everything Bubble”, which has made many of those with mainstream assets richer (at least on paper, and quite possibly temporarily without further action!). The “Everything Bubble” has been built off the back of too much debt - which is totally unsustainable - and an economy which is far too small to support current asset prices without massive and perpetual interventions. There is an almost universal belief in a fictitious world of ever increasing prosperity, despite obvious political and policy madness and badness. Most current government policy is simply highly central bank dependent and aimed purely at elevating asset prices and stopping broader economies from collapsing in an overly financialised world.

By perpetually applying crisis-like stimulus, great distortions and inefficiencies in capital allocation have occurred. These include vast numbers of listed and unlisted ‘zombie’ companies just waiting to destroy the wealth of ‘zombie’ index investors, distorted and elevated housing markets, and outrageous unlisted valuations including venture capital “Ponzi” investing schemes valued as multibillion dollar ‘unicorns’. There is a great price that has to be paid for all of this.

Slowly but surely, we are now seeing signs of economic and market strain as the global economic and financial system wilts under the strain of reality. Simply trying to encourage people to borrow more money through cheap debt is butting up against the reality of a future which many can now recognise as simply unsustainable. While money is cheap, the proletariat class can’t afford to borrow and spend more given their income prospects, and what the wealthy can buy with cheap money is already overpriced and hence unattractive. Governments could be taking advantage of long term cheap money to fund real economic growth and pro-growth initiatives, but have chosen to largely sit on their hands for now.

Somewhat amazingly, no one has yet seemingly told many equity and property markets that there is a recession and crisis coming soon, and that equities and property tend to suffer large falls when there is a recession! That said, many of these markets have largely gone nowhere for some time, held up by perpetual central bank interventions. Perhaps then, the best investors can realistically hope for is these markets continue to oscillate but stay elevated for a long time because of continuing easy money, rather than imminently collapse to correspond with real economic prospects. However, unfortunately, history seems to suggest a crisis is more likely than a range trading market, and that central banks will ultimately prove impotent. It is easy to understand why most investors would completely lose confidence in our fictitious economies and asset prices if they truly understood them, and this is cause for great concern. Try to remember that change comes slowly, but then all at once.

It is of course very important to understand that to be wealthy, you have to stay wealthy; that means surviving and protecting capital through adverse economic and financial market conditions. In fact, it is simple mathematics that large negative returns destroy long term compounded returns, and hence large losses should be avoided at all costs. Effectively, the size of ones’ gains in bull markets are far less important than avoiding large losses in bear markets. This is the reason why Rule no 1 is always “Don’t lose money”. In this context, it is easy to understand why given the market and economic conditions now is such an attractive time to look for an alternative approach.

Where then to invest when there is an everything bubble? Asset prices being almost uniformly too high have led many successful high net worth investors to build up cash, and wait patiently for what they see as the “inevitable” falls that have come in every cycle before this one. This could work if markets do indeed collapse imminently. But what if prices simply stay static, offering no opportunity to ever deploy the cash prospectively? In this case, gradually all traditional asset classes including cash will simply suffer years of no effective return.

Is there then an option to preserve wealth and yet still target positive absolute returns regardless of what happens to markets? Indeed, there is. One can benefit from both capital preservation and more prospective returns than cash through investing dynamically, selectively, and skilfully in absolute return managers whose return streams are not market dependent. Simply put, if the market is ripe for a fall or years of low returns, simply avoid and minimise this risk by investing in unrelated skill-based returns which offer many of the benefits of cash, but with much better return prospects than cash. In this way, investors can win either way – they can make money regardless of whether markets continue to defy gravity, yet they can also protect capital if equity markets collapse.

Of course, implementation of such an approach requires significant effort and skill, and is genuinely a strategy that investors are best using skilled fund managers to implement. Such approaches are not widely available, or even widely understood as an option - and hence can’t be used by all investors. Most investors will always be fooled by strong past returns and low interest rates into buying more overpriced assets at the end of a cycle through “low cost” (high price!) index strategies, or borrowing cheaply to buy more overpriced property. After all, most investors think that there is no alternative to losing money in a recession or bear market. But there is an obvious alternative – and that is using genuine alternatives! This alternative path can and should protect your capital from large losses and adverse market conditions, yet – unlike cash – offers strong prospects of an attractive return stream as well as long as it is skilfully implemented.

In summary and simply put, if traditional markets are ripe for a fall or years of low returns, simply avoid the risk by investing in genuine non-market dependent and liquid alternatives. This can be done skilfully and carefully and in a diversified and hence safer way by experienced investment professionals running a dynamically managed multi-asset fund of fund type approach. In this way, investors can make money if markets continue to defy gravity, and they can protect capital if equity markets collapse. Investors can also better target the absolute return streams many of them are looking for.

Important Notice Jerome Lander is Managing Director of boutique investment firm Procapital. He is a portfolio manager of the Lucerne Alternative Investments Fund with Lucerne Partners, and outcome based portfolios with Dynamic Asset Consulting Pty Ltd, and a representative of Harvest Lane Capital Pty Ltd (CAR 000439644). These provide differentiated, outcome based investment portfolios to financial advisers and their clients. This communication is for informational purposes only, and is a thought piece which represents the views of the author alone. It is not intended as an offer for the purchase or sale of any financial instrument. It does not constitute personal or financial advice of any kind and should not be relied upon as such – investors should consult their financial advisers before making any investment decision. This article’s accuracy cannot be assured. All opinions and views expressed constitute judgment as of the date of writing and may change at any time without notice and without obligation.

Jerome Lander
Chief Investment Officer

Dr Jerome Lander is a highly experienced, proven Portfolio Manager and a specialist in outcome-based and absolute return investing, which is a client centric approach aligned with many peoples' preferences - and one which is well suited to today's...

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