7IM’s Tirmizi: Five things investors should do when the market crashes

Finance movies are no exception here. The setting is always the high intensity trading floor, and the characters are unscrupulous Gordon Gekkos or Jordan Belforts.

But, that is not a fair reflection of investing.

As portfolio managers, we spend much of our time monitoring the world, reviewing the positions we already have and tweaking our process.

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Of course, there will be moments of drama. The 2020 recession was one of those periods. We made a lot of changes to portfolios but these were only effective because we had the right process in place.

Dealing with the unexpected

In 1935, the US army set out to test the new B-17 bombers. On its first test flight, the plane crashed due to a ‘pilot error’.

This new plane was too complicated to be left to the memory of any pilot.

But the orders were in, so they had to figure out what to do and came up with an ingeniously simple approach.

They created a pilot’s checklist: checks for take-off, flight, landing, and taxiing.

With the checklist in hand, B-17s flew a total of 1.8 million miles without one accident.

The checklists provided two main benefits. Firstly, they helped with memory recall, especially with mundane matters that are easily overlooked in more drastic events.

A second effect was to make explicit the minimum, expected steps in complex processes.

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Multi-asset portfolios can be equally complex in times of stress. There are too many steps to remember from memory alone.

Having an investor checklist can help to keep things simple and allow investors to make the right changes at the right time.

Taking decisive action

Key aspects of any investor’s checklist should include:

1. Trigger levels for portfolio weightings

Rebalancing portfolios in volatile markets can feel hard when the world appears to be falling apart around you.

However, it can often be the right and necessary thing to do and can be made easiest if you have set up a process ahead of time.

For example, as equity markets fell in March, we moved portfolios substantially away from target allocations – equity holdings were about a third lower than they should have been.

Our checklist made sure we rebalanced portfolios when weights moved past trigger levels. So, we sold bonds and cash to buy beaten up equities.

2. Economic scenario analysis

Rebalancing portfolios is the first step. But to change positions, we need to take a view on where the world is going.

Our checklist guides us towards scenario analysis in times of uncertainty, rather than focusing on one big call.

In the middle of the 2020 market volatility, we mapped out a range of different economic scenarios (V+, V, L and U) to give us an idea of the investment possibilities.

3. Price triggers

It can often be tempting to stick with what’s worked. But having pre-defined price triggers, alongside scenario analysis, can embolden you to take decisive action when necessary.

For example, by April last year, some parts of our portfolios had performed extremely well during the sell-off – particularly our alternatives basket (up nearly 20%) and position in US healthcare (outperforming the wider market by 15%). Rather than just sticking with what was working at the time though, our scenarios and pre-defined price triggers told us to take profits on these defensive positions and reallocate into risky assets.

4. Dashboard of economic & market indicators

We have a dashboard of economic and market indicators we look at regularly – which strips out the human emotions.

This proved invaluable during the spring of 2020.

Despite the dizzying flow of negative information, our dashboards were telling us that an economic recovery was imminent.

As such, we added to credit and equities.

With the broad portfolio risks being managed first, we then had time to focus on more specific long-term opportunities, tilting towards the winners of the next cycle.

5. Waiting for the next cycle

The large fiscal stimulus combined with unprecedented pent-up savings sets up an outlook for strong and long-lasting economic growth.

Our role as investors is to use the processes and discipline in place to be positioned for this when it arrives. 

This is what investing is: find the opportunities, allocate, and then hold. The bit of the job you do not see on film.

Of course, as the world exits crisis mode, we will keep monitoring our dashboards, rebalancing the portfolios and keep checking those triggers.

But now those same checklists, in contrast to last year, are now telling us to not move portfolios.

We spent the last year tilting our portfolios towards the new economic cycle. Now we wait…

Ahmer Tirmizi is a senior investment strategist at 7IM

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