This year, markets experienced their fastest crash ever. Most investors started the year being optimistic. However, by mid-February, global equity markets had dropped by over 30%.
In a matter of weeks, two and a half years of equity market gains were erased, volatility rose to unprecedented levels, and markets were contending with intra-day price swings of over 5%. Investors scrambled for the exit, looking for any safe haven they could find, most settled on cash, and as a result over $130bn was withdrawn from capital markets.
Now the dust has settled, the question on investors' minds is: when do I buy back in? History teaches us that the strongest equity market rallies often come right after the sharpest falls, and we have just experienced the largest fall since the global financial crisis. Furthermore, the yields on most credit markets are higher than they have been in a decade, and potentially the highest they will be for the next decade. To not invest now could be to miss out on the opportunity of a lifetime for long term investors.
What's the best way to regain market access? Of late, many investors have favoured passive investing, which offers low-cost exposure to thousands of investment markets. However, investors concerned with preserving capital should now think about diversifying their holdings.
As the market environment changes, so must investors. Two tools that many thought to be obsolete should be reconsidered - active asset allocation and defensive diversifiers. The utility of active asset allocation was easy to overlook in a market environment where all asset classes were going up. However, as volatility returns, the ability to actively and meaningfully alter the market exposure of a portfolio is paramount. Advocates of static asset allocation were caught out earlier this year, watching from the side-lines as markets tumbled and they were unable to de-risk their portfolios. Conversely, active asset allocators were able to react and adjust their portfolios to minimise losses.
Defensive diversifiers had likewise fallen out of favour, as the powerful performance of a simple 60/40 portfolio raised questions around their usefulness. Unfortunately, government bonds are unlikely to provide the same support going forward as they have in the past. In this environment, investors need to cast a wider net when looking for downside protection. The inclusion in portfolios of gold, defensive currencies and momentum strategies all need to be considered.
The last remaining question is how to introduce these tools into your portfolio? The simplest way is by using flexible strategies, sometimes known as total return strategies or diversified growth funds. These strategies represent a broad church of investment techniques. Some only take long exposure, while others go short, some are manager driven whereas others are systematic, some take global exposures while others focus on a specific region. However, in general, they provide market access, but maintain very wide investment bands, allowing for active asset allocation. They also make extensive use of defensive diversifiers, holding an array of bonds and equities as well as alternatives and commodities, taking short positions and using sophisticated, less directional, trading strategies. As a result, flexible funds can deliver higher returns than cash savings account with better capital protection than passive funds. The proof, as ever, is in the pudding, and during COVID-19 flexible strategies have not disappointed. They successfully controlled drawdowns, and many delivered positive returns.
Average returns for managers in March 2020, by bFinance Multi-Asset sector
|Strategy||Approximate average performance|
Multi Asset Absolute Return (flexible funds)
Global Equity (MSCI ACWI USD)
Hugo Thompson is multi-asset product specialist at HSBC GAM