Resilience in the face of uncertainty

Investing involves taking on risk

We don’t know what the future will hold. But we can usually build a reasonable set of expectations about what might happen. The potential impact can be tested. And portfolios can be prepared. A sudden stop in economic and financial markets was a foreseeable risk. We wrote about the risk arising from sudden exogenous shocks, excess leverage, or policy error in November. We didn’t know which of the three risks would eventuate. We expected a credit deleveraging. We got an exogenous shock. Different drivers of a similar portfolio risk. Uncertainty is different to risk. When the outlook is truly uncertain, we can’t easily build a set of expectations about the outlook. With Covid-19, we face an uncertain outlook. We don’t know how to quantify the potential human and economic cost.

Focus on portfolio resilience

As retail investors, we have fewer levers to pull to prepare for risky outlooks. But we can still build resilient portfolios that allow us to engage in market upside but protect against the downside risk. We started that process in 2019 – and detailed the actions all investors could take to build resilient portfolios in our Oreana 2020 Medium-Term Outlook.

Know your objectives

It is harder to prepare for uncertainty like the impact of Covid-19. We don’t know how to fully quantify the potential impacts. So as investors we should focus on what we do know. And that is our investment objective. What return do you want to achieve over the long-term? How much risk are you willing to take? How long is your time frame for those risk and return objectives – are you close to retirement (probably can take on less risk) or just starting out (probably can take on more risk)?

Review your risk

The answers to those questions will help you decide how much risk you can adopt, even in the face of a truly uncertain outlook like Covid-19 is presenting. Our observation has been that many retail investors have more equity risk in their portfolios than is required to meet most sensible investment objectives. For example, a cash plus 4% return objective could have been achieved in a equity/bond portfolio over the past 20 years with just 73% exposure to equities. Over the past 5 years, that could have been achieved with a 15% exposure to equities. If the current uncertainty around Covid-19 has you worried, review your portfolio risk. You may have too much.

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