By Greg Rodger on July 30, 2021
When stock markets around the world plunged in early 2020 as the COVID-19 pandemic began to spread; investors were understandably shaken. With businesses shuttered, economies grinding to a near halt, and unemployment skyrocketing it was difficult to determine how low stocks might fall and when things might begin to improve. At the time it was understandable why some investors hit the sell button and chose to sit on the sidelines until greater certainty emerged as to how and when the virus might be contained. This seemed like a logical response given the unprecedented uncertainty. But just a few short months later those same investors were likely regretting their sell decision as global stock markets staged a rapid rebound and quickly went on to new all-time highs.
One of the ways to avoid the impulse to sell in uncertain times is to be invested in a portfolio that is designed for multiple outcomes. If equity markets are down by 30% and your portfolio is down by single digits you are less likely to panic-sell at an inopportune time. But how is this achieved? Do you need to forego significant upside in the positive markets to achieve this? Yes, you will need to be prepared to not always have eye-popping returns when markets are surging higher (but do you really need this). However, if done correctly, you also won’t experience the panic-inducing declines, and we would argue that you are likely to do better over the fullness of time versus constantly swinging for the fences.
Constructing a portfolio that is designed for multiple outcomes involves diversification of both public and private market securities and the careful selection of the strategies employed for each component of the portfolio. Your goal should be to have at least some investments that are always producing positive returns no matter what the markets serve up. To use a gardening analogy; if you plant only tulips you will be thrilled with your vibrant and colourful garden in the spring, but dismayed as you look out at an empty patch of soil throughout the summer. To avoid this dismay when investing requires an understanding of what is likely to perform well when other investments are falling. This is one reason why at least a small allocation to government bonds, even with their extremely low yields, should still be considered for most investors’ portfolios. As equity markets went into freefall last year, government bond prices soared which not only cushioned the blow for the overall portfolio but provided a ready source of cash for investors with the discipline to rebalance and buy more equities when stock prices were down.
We are also firm believers in cash flow oriented investments – those that pay regular cash distributions. Being paid a meaningful and consistent distribution while you wait for prices to recover is more comfortable than relying on price recovery alone. Also, investing in strategies that track an index means, by definition, that you are going to experience both the full gains and the full declines of that index (minus the fees). However, there are equity (and bond) strategies that exist that have demonstrated an ability to fall less when markets are declining, on average over time, and also participate in most of the upside.
Combining all of these ideas into a portfolio may not be as exciting as a garden full of tulips in the spring, but the protection of capital in down markets allows investors to sleep better and prevents them from making emotional decisions at market lows.