Fund management in times of extreme market change

As someone who has managed and advised fund managers through some wild market gyrations, I am setting out some thoughts and comment which may help focus minds through the current turmoil.

History repeats - but never the same way twice.

• In 1972-74 the FT30 index of UK equities fell from 544 to below 150, rebounded sharply but then took years to re-establish former levels.
• Autumn 1981 saw 25-year gilts yielding over 15%.
• Between March 1984 and January 1985 the pound sterling fell from US$1.49 to US$1.08.
• October 1987 saw the Black Monday crash where the Dow Jones index (DJII) fell 22% in a single day.
• Most people remember the consequences of the 2008 banking crisis.
• None of these was caused by a pandemic (though of course plague and waves of sickness sweeping Europe in past centuries did create dramatic economic consequences in their time).

How do I know when a market is turning?

You can't know at the time and you won't know for quite a while after. There are points, however, when there does seem to be a unanimous view that fundamentals can only get much worse but this is no longer based on underlying change. One of these points will prove, in time, to have been the bottom for that market. Be aware that most market assumptions, valuation metrics and models are now all out of date and will be replaced by new thinking triggered by new emphases as to which criteria will become most relevant. Inter-market relationship norms will be reset and there will be follow through consequences.

Similarly, bond ratings and credit ratings are all now historic and will be reviewed in time. You will need to do some of this now. Companies perceived to be in stable sectors may have awkward banking covenants. Private equity funded businesses may have to compete in a limited pool for fresh capital. Economic data, epidemeological data and medical input will all be subject to major revision. There is massive scope for following opportunities and market mis-pricing to generate spectacular gains (and losses). There will be massive surprises - companies folding, cheeky takeover bids, tax changes …

So, fund managers should focus on their remit (investment horizon, underlying liabilities to be met), spread risk and timing (which will not produce the maximum possible performance but will avoid catastrophic outcomes).

What do I do?

Practically,
• Fund managers need to keep clear heads and be more prepared than usual to make their own decisions.
• Be prepared to stand back from the hourly minutiae; decisions taken now will affect the very long term.
• Don't rely on general market sentiment to support your decisions; it will be wrong much of the time. If possible, find a sounding board or mentor to support (and query) validation from more arm's length, longer term thinking sources.
• Understand that most currently available data is wrong, irrelevant or simply just historic. Investing is for future returns.
• As data is revised and as sentiment lurches from gloom to cheer and back, be prepared to repeatedly re-evaluate all the conclusions you may have just accepted.
• Expect more surprises
• Don't put all your eggs in one basket
• You may have new streams of investment focus. You may need to restructure investment teams to reflect this change.

What else will be different?

At the time of writing (17 April) it seems that factors to consider include:
• Timeframe: Unknowns around the timing of the unprecedented and unplanned disruption to the world's major economies by Covid-19 can be expected to morph into a new norm within 12-24 months.
• Border enforcement: Country by country control can be expected to remain for some time. This changes the underlying principles of the EU (and makes Brexit less of a drama), dramatically reduces travel and confounds global trade. As each country is affected and responds differently, so economies will drift out of sync.
• Psychology: Lockdown, hospital overloads, job insecurity and deaths all provide a more immediate and personal hit than, for example, discussions about money supply and the banking system. 

We may see a party time boom followed by a reality recession. It is very likely that governments will attempt to smooth a path to recovery with further QE and other tools but working blindly based on out of date data. This, with exceptional commodity pricing, will create new economic instabilities. To all these factors, acceptance or rejection of politicians' behaviour could lead to major political change.