Covid-19 has sent markets into a tailspin. Even the calmest investors are breathing heavily as their watch stocks in their portfolio fall by double-digit percentages on a daily basis. Situations like these can have a huge impact on long-term outcomes, for example, switching to cash after the falls have happened and failing reinvest. Being prepared during the good times is essential for maintaining your cool when that black swan appears.

In light of this unprecedented volatility, we reached out to three fund managers to hear their take on how to handle a crisis. Responses come from Russell Muldoon, Reqon Capital; Weimin Xie, MX Capital; and David Moberley, Paradice Investment Management.

Cash is king once again

Russell Muldoon, Reqon Capital

Probably this applies before the market crashes...If you're going to panic, panic early! By working through problems as they arise, keeping an eye out and looking for signs of cracks in markets, such as the bond market moving ahead of equities (flight to safety) for example, use all your resources to quickly and efficiently reposition your portfolio. Going to cash is our number one defence mechanism and is the ‘king’ against a market crash in our view.

If, however you are not fortunate in getting on the front foot early, sometimes it's not too late to sell and continue repositioning your portfolio into a fading market or one that doesn’t fall precipitously like the correction we have just experienced. And, if you feel it’s too late to sell, the application of some hedging we feel is prudent as markets often overreact on the upside and downside and can often go on for longer than anyone expects.

Now while in some circles of the investment management world, using charts or ‘Technical Analysis’ to identify markets or individual business ‘rolling over’ is considered taboo, don’t be fooled – they are incredibly powerful when used correctly. Don't be afraid to use them just because it doesn’t fit someone else’s investment management style. We have found over the years that when combined with a solid understanding of fundamentals (both qualitative and quantitative), they are just another tool in your financial toolkit and have saved us from big issues more times than I care to count. There is information in prices and experience in often reading ‘between the lines’ can play a key role here.

Focus on what’s important

Weimin Xie MX Capital

Having a plan in place to satisfy your financial objective is the most important thing.

For retirees, the most important thing is the certainty of return, so they need lower exposure to equities. For working-age people, it’s the ability to continue adding investment to the market. Not looking at stock prices will help a lot.

We have had the longest bull market in history, we’re due for a bear market. Mentally prepare for the market to fall a lot more from here as valuations are still high relative to historical averages.

Four things to consider in volatile times

David Moberley, Paradice Investment Management

Witnessing several market crashes over the years has taught me some valuable lessons. I have been privileged to work alongside some of the best fund managers in the market at Paradice, which has provided invaluable experience. I also have some excellent mentors to talk through the issues and challenge the existing thinking. In terms of a market crash, there seems to be a similar playbook no matter what the cause. Capital preservation is key, and we will look to protect the portfolio as much as possible. However, it is also important to remember that some of the biggest rallies in history have come out the back of market crashes and there are also plenty of opportunities to take advantage of along the way.

Some things to focus on and consider are below:

  1. Liquidity. Liquidity is very important because if things get disorderly you will be in trouble in illiquid names. Illiquid stocks can rip in bull markets as they are bid up aggressively. Unfortunately, the same thing happens in reverse in bear markets with a large crowd and a small door. With that in mind, act early to high grade your portfolio with larger cap liquid names and reduce any small caps that you aren’t willing to hold and ride out.
  2. Risk. Check your risk metrics and make sure you understand the bets that you have on by reviewing any sector or style bias. Run scenario analysis to understand how your portfolio will perform under various market outcomes but most importantly make sure there are no unintended bets in the portfolio.
  3. Volatility. The volatility in a crash will be extreme and a lot of people get whipsawed, selling on large panic down days and trying to buy back in on ripping up days. Stick to the fundamentals, understand what your game plan is and stay focussed. Don’t be sucked into allowing the price action to drive your views. This is a major error. Remember that large drawdowns are usually followed by a big bounce. However, the market almost always retests the lows multiple times in a bear market.
  4. Balance sheets. This is the most important one. Companies with poor balance sheets cannot weather a downturn like those with great cashflow and low debt. In a bear market, these stocks will underperform on down days and won’t bounce on up days. This ethos is core to our process. In a bear market, anything in your portfolio with excess debt or funding concerns needs to go, unless you are happy to recapitalise it. Also avoid the trap of hiding in companies characterised as defensive assets with aggressive financing structures, these will not perform well despite historically being considered low beta. That said, supporting equity raises for great companies with a bad capital structure can provide some of the greatest opportunities in a downturn.

In conclusion

While it’s always better to be prepared when a crisis hits, that doesn’t mean it’s too late to mitigate the damage. While huge losses have been suffered on the downside, with more potentially to come, markets will recover at some stage, and it’s important to be ready for that day.

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