Financial markets last year were nothing short of unpredictable.
Few would have believed that the S&P 500 would close 2020 16.3 per cent ahead in a year when the global economy was on a knife edge.
While vaccine progress provides some hope for the future, there are still risks to their rollout and distribution. Advisers may be asking how they can protect their client portfolios from future setbacks as we learn to live with Covid.
‘Panic trading’ in response to the latest medical news has proved a poor strategy. When Covid-19 hit, the temptation was to rebalance based on an altered view of the world. However, markets were moving fast and took time to settle.
By trying to rebalance immediately, investors left themselves vulnerable to being out of the market at crucial moments and to some dramatic mis-pricing.
We consciously did not rebalance in our managed portfolio service at the height of market volatility, considering it too much of a risk. Instead, we waited until markets stabilised to appraise the new environment and make adjustments to investor portfolios.
That is not to say that advisers should not strive to build resilience into portfolios and to reflect the altered environment likely to emerge after Covid. Slumps will happen from time to time.
It is just that the next upheaval seldom looks like the last and there is a risk that investors are always looking in the rear-view mirror. In the wake of the global financial crisis, there was wholesale reform of the banking sector, yet investors lingered on this risk during the Covid crisis.
It is possible that they will do the same with the pandemic. Investors need to adapt their portfolios to cope with a range of scenarios because crises are inherently unpredictable.
With that in mind, what does a resilient portfolio look like? Certainly, the answer to this or any other upheaval has not been to retreat into traditionally defensive assets.
While government bonds have performed well over the past year, yields are now so low that their protective characteristics are diminished. The same is true for cash. It may protect a portfolio in extreme conditions, but it is very expensive to hold and the opportunity cost may be significant.
The same is also true for ‘defensive’ equities. Blue chip stalwarts have, in many cases, not proved resilient in this crisis. Some have been on the wrong side of environmental, social and governance trade, while others have seen their business models come under threat.
The idea that investors can simply retreat into blue chips in the face of market turmoil has been blown out of the water. Any analysis of risk needs to be far more nuanced, considering a broad range of factors: interest rate exposure, commodity pricing, the risk-free rate as well as the unique circumstances of the economic environment.