How to create robust portfolios to see you through stormy waters

Financial turbulence has rocked economies across the globe forcing investors to adapt new strategies for the uncertain times ahead.

clock • 3 min read
How to create robust portfolios to see you through stormy waters

Here Nikesh Patel, head of investment strategy at Kempen looks at the key areas and considerations for successfully creating robust portfolios that can survive the buffeting from economic headwinds.

As the economic impact of the pandemic starts to crystallise, it's important to say at the outset that the repercussions are likely to be felt for many years to come.

But which investors have performed best so far? The ones who built robust portfolios.

Someone looking back on this period may well think that a global pandemic was something investors should have been prepared for. In my view, some market surprises cannot be prevented, but most of them can be managed, even if you don't know what form the surprise will take.

So, what do we mean by a ‘robust' portfolio?

Firstly, there needs to be real diversification (not ‘diworsification' which just increases the risk/return trade-off).

And it's important to be robust in terms of risk exposures, particularly avoiding large dominant drivers and making sure that investment risks are integrated with covenant risks.

Operational risks also need to be considered so portfolios can deal with large market swings.

Relationships are important
And the final area where portfolios need to be robust is in terms of relationships with providers and advisors. Harder to measure than the rest but just as important.

Protection strategies have a broad definition, but they need to be thought out well in advance and are no substitute for an inappropriate risk budget.

And then there have been tail-risk strategies that are attracting interest because of the incredible returns - one fund reportedly produced a return of 4000% (before fees). But investors usually only hear about the ones that were successful this time, and many weren't.

Also these kinds of strategies cost performance over many years until the right type of crisis comes along.

For pension trustees, for example, the key consideration is whether they ought to be positioning for further downside protection (for example due to covenant concerns) or seeking out opportunities.

Never waste a good crisis
We're still in the middle of the Covid-19 crisis. As investors we should be prepared to assess and exploit market dislocations when we see them. As the saying goes ‘never waste a good crisis'.

In the last decade we've seen the longest bull run in history, driven mainly by the responses to two crises: the global financial crisis and the sovereign debt crisis. The three great opportunities became credit, interest hedging and equities.

At this moment the clearest apparent opportunities to Kempen are again in the credit segment - across parts of high-yield, securitised credit investment-grade credit and looking further ahead, in distressed debt.

Nimbleness is key
As fiduciary managers we're looking closely at these and have already taken steps to exploit these in our clients' portfolios, while keeping some powder dry for future opportunities. Nimbleness - in portfolio management and fund selection terms is key here.

As for rebalancing portfolios it's important to recognise that not doing so might also be appropriate.

It's also important to remember that the cashflows you need to pay benefits need to be clearly planned for. And with an increasing number of sponsors requesting contribution holidays some schemes will feel the cashflow burden acutely.

A robust investment strategy would have had a plan for cashflows - this could be something as simple as excess cash or with cashflow-matching bonds for a number of years future payments.

Responsive fiduciary managers
Finally, it may be that the current environment has pushed the relationship between a pension scheme or trustee into the spotlight. We've all had to adapt our way of working and I think many organisations have learned that in times of crisis a good fiduciary manager should be reachable and responsive - using technology to bridge the gap between telephone and face to face contact.

Ultimately what trustees need from a good consultant or fiduciary manager is a combination of integrity, expertise, humility and an ability to listen and communicate well.

A crisis is a good opportunity to reflect on whether you have this in your team.  

Watch Kempens' May Market Update Below

Market Update May from Kempen on Vimeo.

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