«Never let a good crisis go to waste.» Whether or not these words were actually uttered by British statesman Winston Churchill toward the end of the Second World War is a matter of debate. But whoever it was, they were right. Because a crisis is not necessarily a bad thing. In fact, it is rather a good test of an investment portfolio’s quality. Experience shows that when putting together and managing an investment portfolio, it is not only the return that matters, but also whether the portfolio can survive a market crash largely unscathed. It is of little use, for example, if investors are successful on average but are forced by a market crash to liquidate their portfolios because they were perhaps overleveraged. Warren Buffet put it in a nutshell when he said: «In order to succeed, you must first survive.»
In a crisis, however, it is important not to lose your nerve in the face of uncertainty and fail to act. Instead, it might make sense to carry out a countercyclical rebalancing exercise. After a sharp correction, portfolio allocation is left in disarray. Instead of an equity allocation of 40%, for example, one suddenly has only 30% because the shares have lost value. The allocation to equities therefore has to be increased again. Disciplined rebalancing means buying at low share prices and selling at high ones. Market dislocations can also be used as buying opportunities. Attractive entry prices for temporarily undervalued assets could reward the few investors who provide the market with liquidity during periods of high stress, while everyone else is just thinking about selling. In order for us as LGT Capital Partners to better exploit these opportunities, we introduced a rule-based system that monitors the market valuation of various asset classes after the financial crisis in 2008. We also defined triggers based on historical data that indicate whether it would be profitable to respond to these valuation signals. During the coronavirus crisis, our rule-based system signaled a number of value-oriented investment opportunities, two of which we have implemented so far. In March, we increased our weighting in both Japanese and European equities.
These are helpful tips, but we all know that it is not always easy to implement an investment concept according to plan in the middle of a crisis. Asset prices are determined not only by fundamental data, but also by the psychology and human biases of investors. One of these psychological traps is the so-called «recency effect.» People tend to attach too much weight to the recent past when analyzing possible future outcomes. As a result, recent information is always considered the most relevant when assessing a situation, because it is the easiest to remember. It is therefore not surprising that investors have valued equities on the basis of the events connected with COVID-19, even though their effects are likely to be short-lived for most companies. The wide gap between short-term and long-term expectations tempts many investors into «market timing.» This means attempting to enter and exit the markets at short notice and at the right time. In most cases, this strategy is not successful, and the investment return may even be reduced because of wrong market timing decisions and transaction costs. In fact, stock market returns follow the 80/20 rule, which states that 20% of the causes usually account for 80% of the effect. A small part of the upward movements in stock markets therefore influences the majority of the result over a longer time horizon. Therefore, if you were away from the stock market for some of those days because of market timing, you would have missed out on a large part of the returns and been unable to benefit from the market rally. An example of this would be the strong recovery phase that began in April this year and has lasted until now, which few market participants would have expected.
So do not let emotions and biases guide you. Avoid constantly watching the news and checking your statement of assets every day. As Winston Churchill once again aptly summed it up: «keep calm and carry on.» A well-conceived and, above all, consistently pursued investment strategy allows you to do so even in difficult times.
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