Coronavirus & The Markets: Five Portfolio Review Tips For Investors
We have experienced extreme volatility in markets in the wake of the COVID-19 pandemic. This is naturally unnerving for investors. Maintaining perspective, understanding risk tolerances and getting advice will help investors get through.
Here are five portfolio review tips investors should consider:
1. Diversification, diversification, diversification
Diversification takes two forms:
Diversification across different asset classes. In times like this low risk asset classes will continue to perform, producing very modest but more certain investment returns. This helps to offset the negative returns generated by higher risk asset classes such as equities, which over time generate higher investment returns, but whose returns are more uncertain over the short term.
Within each asset class, holding a diversified portfolio of securities makes a difference, as not all securities perform the same way in over a specific time period. For example, over the past month Air New Zealand has fallen 64.7 per cent while Fisher and Paykel Healthcare has risen by 10.5 per cent.
2. There’s no crystal ball, so stick with what you know
The key question we all have today is ‘where to from here?’ Rather than let market forecasts drive our investment decisions, portfolio strategy should be formed by reference to what we know, and what we can control.
Governments around the world, including our own, have announced what can only be described as ‘massive’ stimulus packages. The ‘go hard, go early’ mantra has been put into action with capital and stimulus flooding agencies, and markets - to lessen both the human impact of this disease, and temper its economic impact.
This spending, along with the coordinated central bank monetary policy measures enacted over recent days, will help mitigate the worst impact of COVID-19’s economic impacts. It will not though, avoid a period of recession. It is this expected economic downturn, and the obvious impact it will have on company profits and dividends, which has pushed share markets down.
Alongside this, the human impact of COVID-19 and the uncertainty we all face on the spread, severity and ultimately the timing of any vaccine or control, is also clearly weighing heavily on investor sentiment. It is likely to continue to do so until the outlook becomes clearer. In addition, a lack of liquidity in markets is resulting in more aggressive price falls as certain investor groups are forced to sell.
We also know, based on our research and analysis, that a number of high-quality assets and businesses are now trading at prices below our assessed long-term value. Identifying these pockets of value requires fundamental research and an active approach.
There are three main scenarios facing investors:
Markets have already priced-in too much negativity and will start to stabilise and even recover from here.
Share prices stop falling, but also fail to rebound in the near term - if the economic impact of COVID-19 is long-lasting, any recovery in share prices may be drawn out.
The situation worsens before it improves, which could push share prices down further.
Each of these outcomes is possible and assessing the most likely outcome is extremely difficult, particularly as that requires a deep understanding of virology. However, it is possible to postulate different economic scenarios resulting from the pandemic to assess what might be priced in.
Active portfolio investors can use information to try to enhance their investment portfolio returns. For other investors, it is important to ensure that their portfolios continue to be structured so as to ensure it continues to meet their investment goals and aligns with their risk tolerance over the long term.
3. Revisit your risk tolerance and asset allocation
Mutual Equity's Head of Wealth Research, recently commented that, “It is at times like this that investors need to think about whether their asset allocation (how a portfolio is allocated across the different asset classes) reflects their risk tolerance.”
Investors who have a high exposure to equities and are uncomfortable with the high exposure are probably more conservative in their risk tolerance than they previously perceived.
How your portfolio is split between lower-risk income assets (cash and bonds) and growth assets (shares, property and alternatives) is the key driver of your portfolio’s risk and return profile. As such, your portfolio’s asset allocation always warrants close attention, but even more so now.
4. Is it time to rebalance?
The term ‘rebalancing’ describes the process of ensuring the mix of assets in a portfolio aligns with the target asset allocation.
The fall in equity markets may mean some will have seen a decline in their equity exposure and a corresponding increase in the exposure to income assets (cash and bonds). While this may feel counterintuitive, investors who are comfortable with their target asset allocation should consider rebalancing their portfolios back towards equities.
Rebalancing proves itself over every market cycle as an effective way to capture upside by forcing us to allocate capital to equities during periods of market stress. Lower entry prices imply higher expected returns over the long term. Of course, a degree of resilience will be required as further volatility can be expected.
5. Safety in numbers
To mitigate market timing risk, allocate capital carefully and in tranches over a period of time. Favour companies that have strong industry positions and with solid balance sheets that can withstand the inevitable short-term earnings shock. It is companies such as these which should benefit most from the re-rating that generally occurs once confidence returns. In this environment, in our view, investors need to be discerning. It is unlikely to be as simple as buying ‘the market’.
All investors will be affected by this sudden fall in markets. However, as long as your strategy aligns with your risk tolerance and goals, and you intend to be invested for the long-term, staying the course remains a strategy that should be rewarded over time.