It’s Time to Get off the Fence

For years we have been urged to invest passively, in index funds that have low fees, low turnover and as such are tax efficient. We have been told, for the most part correctly, that most active equity managers do not outperform the indices.

This may be correct in a steadily rising equity market. But not always – and not now. We experienced in February and March the sharpest market sell-off since the Great Depression of approximately 30%, and while at the time of writing there has been some recovery, uncertainty lingers. We do not know how long the current coronavirus crisis will impact both Wall Street and Main Street. Markets could sell off again once there is more clarity on the degree of economic damage, or should there be further delays in getting the economy back on track.

In this environment, most alternative, hedged and/or absolute return strategies aimed at mitigating market exposure, have not worked either. Panic selling has caused a liquidity crunch, with margin calls forcing leveraged investors to sell often at great loss.

I am reminded of the insights of two wise investors whom I met as a young analyst. My early career in the mid-to late 90’s was spent evaluating absolute return and relative value hedge funds, i.e. those strategies that were supposedly uncorrelated to the equity markets.

I presented to the first wise man, an English nobleman, a stable of these so-called managers for investment – convertible, merger, capital structure, mortgage and even commodity arbitrageurs. I presented well-structured strategies, with enviably consistent track records, aimed at making money in any environment. “Hmm”, he commented, “these are American strategies”.

This basically meant that they worked best (or only) when the dollar was strong, with positive real interest rates (i.e. CDs out-earned inflation) and robust financial activity, all of which allowed Wall Street’s alchemists to concoct various flavors of financial engineering.

The second wise man was a legendary yet secretive macro manager who ran a portfolio for a well-known hedge fund. He spelled out to us in great detail his then current investment thesis and positioning, where after he stated plainly, “I may change my mind tomorrow”.

We learn from them both that one cannot ignore macro-economic trends, especially during times of market stress, and that one must be willing to make active investment choices.

It is hard to time markets, and we do not advocate getting in and out. However, it is imperative to navigate the markets as best as one can. Generic indices include both those sectors that are more attractive today, such as consumer staples, healthcare or information technology, as well as those that may be deemed less so, for example, energy and cyclicals. It’s now time to be more selective.

Going forward, one can no longer rely on either general indexation, nor many generic “smart beta” alternative strategies that worked in bull markets. This does not mean there will not be good investment opportunities. Investors and advisors are going to have to work harder to earn their keep and stay away from sectors or strategies which may endure continued pain. If an investment strategy seems too good to be true, it probably is.

One must have a view now, act on it and be willing to make changes if necessary. It’s time to get off the fence.

 
Norman H Chait, CFA is the Managing Principal at Nardis Advisors LLC

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Disclaimer: Nardis Advisors LLC (“Nardis”) is a Registered Investment Advisory Firm regulated by the U.S Securities and Exchange Commission in accordance and compliance with applicable securities laws and regulations. Nardis does not render or offer to render personalized investment advice through this medium. The information provided herein is for informational purposes only and does not constitute financial, investment or legal advice. Investment advice can only be rendered after delivery of the Firm’s disclosure statement (Form ADV Part 2) and execution of an investment advisory agreement between the client and Nardis.