reflections - Jacob Shah

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Earlier this year I experienced my first financial crisis since joining the financial services industry five years ago and it didn’t feel like what I expected. I had read about previous financial crises, for example the global financial crisis, and this didn’t feel like much of a crisis. 

Mass unemployment was avoided because of the furlough scheme, a wave of business defaults was avoided due to government support for businesses. The market turmoil was also over almost as soon as it began. This feeling certainly wouldn’t have been helped by me spending seven months working from home in my pyjamas!

Here are three observations from my time as a consultant during my first financial crisis. 

There wasn’t as much investment action taken as I expected

Now I wasn’t expecting some Big Short-esque flash sale of assets at all. And there was still lots of action taken in the form of extra meetings and calls with clients to discuss the impact of the Covid-19 on their assets or funding position. However, I was surprised that, on the whole, there were very few investment transactions made in the first half of the year.

In their defence, well-funded DB pension schemes with low-risk investment strategies experienced a limited impact on their positions. For them, the hard work had already been done over the last few years to de-risk their investment strategies and build more resilient portfolios. So, these clients didn’t need to rebalance into growth assets to still meet their objectives.

However, some investors did see falls in their growth assets. In this case, I thought clients would jump at the opportunity to top up their growth allocations by buying investments that were 30% cheaper than a month ago! Instead, given how difficult it is to invest in wild markets, many clients sat on the fence, hesitated and / or delayed.
On average LCP’s DB pension scheme clients over March 2020 saw… 

  • Asset values fall 5.7%
  • Funding levels fall 3.8%

To me, this was behavioural finance 101 in action – that is an action that prevents us from making the right investment choices. In this instance, we have a combination of:

  • Myopic loss aversion – we are more sensitive to losses than gains, and overly influenced by short-term considerations; and
  • Omission bias (also known as the trolley problem, which is explained nicely by Ted-Ed here) – we judge an action that results in a loss much more harshly than we judge an inaction that resulted in an equal opportunity cost.

But more than anything this shows just how hard decision-making is in these situations, it’s something you do have to live through to really understand. 

I’m a strong believer in rebalancing. It's a mechanism that as markets are falling you will be buying equities, and the exact opposite happens as markets come back up. You never have to figure out where the bottom or the top is!  Following a disciplined approach to rebalancing can also help avoid behavioural biases in investment decision making. However, one lesson from the crisis is that however simple things seem, no decision is easy in the midst of market turmoil. This is where consultants can add value by advising clients to follow a disciplined approach to rebalancing in the midst of turmoil, rather than ending up in a position where you look back with regret with the  benefit of hindsight. 

The ability to be dynamic and flexible is valuable

As it turned out, the opportunity to buy assets at cheap valuations was only short-lived given the unprecedented weight of central bank and government action that came along and supported markets. For example, it only took global developed equities around 5 months to rebound from their lows in March 2020 back to 2019 levels. Half a year may sound like a significant amount of time, however, this isn’t necessarily the case in the institutional investor world!

What this highlighted to me is if you want to be able to capitalise on opportunities, which you are largely unable to predict, the ability to be dynamic and flexible is valuable. You need the right governance structures to make decisions in a timely fashion and the right investment arrangements to be able to implement any changes quickly. 

In practice, this means setting yourself up in the right way in the good times so you can benefit in the bad times. For clients who only have a limited amount of time to focus on investments, they will be supported by their advisers to put in place the right investment and governance structures, and reliant on their active managers to be dynamic and adjust their asset allocations quickly in challenging times. However, for other clients there are some key items that they can consider, such as derivatives, to add value to their investment strategies. 

Markets are very short-termist and sentiment driven! 

I already knew this, but the extent to which this happened in 2020 has helped cement this view in my mind.

For example, before the Pfizer vaccine news in November 2020, many economists and political broadcasters predicted a vaccine would be available by mid-2021. On the day the news broke, Rolls-Royce share price jumped up 40%. However, doesn’t this news only represent a vaccine coming (just) a few months earlier than expected? Or perhaps a vaccine with a higher efficacy than expected? More pertinently, given a vaccine was already expected, does this news change the shorter- or longer-term prospects for Rolls Royce such that a 40% share price increase is reasonable?

Shares like Rolls-Royce, EasyJet and Cineworld leapt around 40% when the Pfizer vaccine was announced. But didn’t markets already price in, to an extent, a vaccine coming in the near future? 

Don’t get me wrong, the Pfizer news is a significant development. However, it will take some time for the vaccine to be effectively distributed. The recent leap in markets would therefore appear to be an overreaction.

To me, this demonstrates that market participants are heavily focussed on short-term results (to the detriment of long-term investors such as pension schemes) and are very sentiment driven. Given this, as a long-term investor, it’s important not to be swayed by short-term “noise”, but also to be prepared for when this noise presents attractive opportunities. 

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