The Covid-19 induced market crash offers several lessons for investors. Some are reminders of perennial investment pitfalls, while others indicate evolving market dynamics that could help guide investor focus in the coming decade.
The pandemic has provided an ideal case study to illustrate market efficiency, puncture common myths and test various popular hypotheses.
Below are the top six lessons for investors following the crash:
1. Do not try to predict the market
For the past few years, market commentators have been predicting the end of the bull market that began after the financial crisis in March 2009 and eventually ended in March 2020; a record 11-year run.
Throughout this period, there have been hundreds of well-articulated research reports arguing that the bull market was long in the tooth and another crash must therefore be imminent.
However, few commentators (if indeed any at all) accurately predicted that markets would come crashing down in March 2020 due to a pandemic triggering unprecedented business interruption from a global lockdown.
A crystal ball that does not accurately reveal both the timing and reason for a stock market crash is of limited use and may hurt rather than help investors, as further discussed below.
2. Cash is not king - stay fully invested
The popular axiom 'Keep some dry powder' implies that it is prudent to have cash available to deploy if the market pulls back to more attractive levels. However, while well-intended, it is more likely to harm rather than benefit long-term investors for two reasons.
First, in today's low interest rate environment, the return on cash is essentially zero. Investors with a long-term horizon who allocate a portion of their funds to cash implicitly choose to not be fully invested, thus foregoing a market return and (likely) incurring an opportunity cost.
Second, taking the decisive step to go against the flow and deploy cash when the market falls requires immense mental strength. Unfortunately, our experience is that both professional and private investors rarely step in with conviction when the opportunity presents itself.
Investors hoarding cash risk losing at both ends. They are short-changed by missing the market rally before the crash and then typically fail to jump onboard amidst the panic, thus remaining on the sideline as the market swiftly returns to pre-crash highs.
3. Passive investing is not a bubble, at least not yet
Active managers have long complained that quantitative easing, ETF proliferation and momentum strategies have distorted the equity market by suppressing volatility and increasing correlations, making it difficult to beat their benchmarks.
However, with the recent pandemic-led disruption, the VIX index spiked to a 30-year high 16 March, meaning you could be mistaken for thinking that the equity market during this turmoil would be a "stock picker's paradise".
Reviewing the track record of some 5,000 actively managed equity funds in Bloomberg's database, however, reveals that over two thirds underperformed their respective benchmark during March and over the first quarter.
Clearly, active managers (still) need to raise their game to stay alive and justify their existence as passive investing looks set to continue its march towards market domination.
However, every cloud has a silver lining. Nearly one third of active managers outperformed, sometimes by a considerable margin, and therefore may offer investors a (much) better option than a plain vanilla index fund.