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Uncorrelated
reflections - Phil Boyle

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I've been a consultant since 1989 and so I'm a veteran of a number of financial crises in the UK and agree with Buffet that in times of financial stress “we are all dominoes spaced closely together.”

However, the best way to avoid being a domino is to learn valuable lessons from the crisis and remember them as memories fade.

Lessons on risk

Low risk just means that you do not know what they are yet - but it is very difficult to plan for risks that you can’t even imagine may exist.

Only a select few including Bill Gates and (reportedly) Nostradamus had envisioned that the world could catch a flu that would turn our lives upside down. Most investors and consultants have overestimated their ability to deal with market falls and liquidity events (even after the 2000 tech boom and 2009 liquidity crisis) and so Covid has taught us “highly unlikely does not mean impossible”.

I think investors need to start with a worst case scenario and then add an extra margin for events that cannot be imagined.

I finally surrendered to negative gilt yields

I remember when the real yield on index-linked gilts was nearly 4%pa above inflation and throughout my career I have watched this fall inexorably to 2%pa below inflation which is a colossal, financial tsunami (I am running out of hyperbole). 

For the last decade my Kabaddi style chant has been, negative real yields can’t last, negative real yields can’t last … but I have now officially stopped waiting for the world to return to my memory of “normal” and Covid has taught me negative yields are not an economic anomaly but a version of normal.

Make sure you have a good plan in place and make sure you stick to it

As an investment consultant, 10% of our work is designing really good investment strategies and the other 90% is helping our clients stick to them. Investors in the Covid crisis have performed well if they have simply:

  • set a good long-term target investment strategy;
  • which avoids concentrated risks and exploits diversification;
  • with sensible control ranges;
  • a well thought out cash flow management and rebalancing regime; and
  • resisted the panic that Covid caused to calmly implement their well thought out plans.

This is because any good investment policy would be buying equities after they fall (which can then make a profit on the rebound) - though the timing does depend on how frequently you rebalance.

Do not time the market

When daily volatility is high and driven by the newspaper headlines rather than economic fundamentals then do not try to time the market. If you need to sell something then sell it gradually in tranches and if you need to buy something then buy it in tranches. This also helps control dealing costs. Easy to forget this simple discipline when the world is turned upside down.

Security of income

The importance of liquidity is not a new Covid lesson and that liquidity disappears in a crisis should not be a surprise to anyone. However, Covid sparked a dividend drought which would have hurt any retired investors looking to capture and use the dividends as a source of income.

I learned a couple of simple lessons:

  1. Firstly, the amount I can rely on a dividend is not to do with how stable the dividend is or how long the company has paid a dividend but is related to how many times that dividend is covered by the profits of the business. For example. Shell cut its dividend for the first time since World War II and the cut was deep as it reduced the income to investors by 2/3rds and the main reason was that the pre-Covid dividend cover was only around 1.4 times so the company had to retain cash for Covid uncertainty whilst suffering falling profits.
  2. Secondly, any income stream that is either directly or indirectly backed by a government or that is part of the fabric of our society is incredibly valuable in a crisis so I am falling back in love with infrastructure assets.

Zombies can catch the flu

In the last decade we have witnessed the growth of 'zombie companies' who are too weak to grow and they can survive by servicing their debt while interest rates are low but they cannot reduce the principal amount or fill the pension deficit hole.

Research by Banerjee and Hofmann in 2008 ('The rise of zombie firms: causes and consequences') estimated that each 1% share in our economy taken up by zombie companies will reduce productivity growth by 0.3%pa. It's small wonder then that the slowdown in Britain’s productivity growth over the last decade is the worst since the start of the Industrial Revolution 250 years ago.

It may be heresy to think it as many workers approach Christmas with a redundancy letter being their only gift, but a small light at the end of the Covid tunnel could be that we are now seeing the zombies fall when the warm rug of government bail-outs is withdrawn and we could be in for an economic reboot and period of productivity growth.

So, there comes a time at the start of every financial crisis when the Zoom call goes quiet and all eyes turn to the investment consultant for insight and wisdom about how to surf through the financial storm. If that is the time your consultant starts to have lots of great ideas about liquidity and rebalancing then you might be in for a rough ride as all those ideas should have been implemented already and surviving the crisis is about remaining calm and implementing the plans you already have in place. As Churchill said: “When you are going through hell, keep going.”

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