Last week, we talked about preparing for Brexit – and in the end, Britain decided to leave the EU. With this has come a roller-coaster ride for all financial markets.
I mentioned in the previous article, that the prudent thing to do was to reduce risk. And that the event itself was a good lesson in risk management for many investors.
Knowing what to do next
While risk management is a continuous exercise, Brexit has just illustrated that sometimes it pays to be cautious and to take one’s foot off the gas pedal.
In market terminology, it is a risk-off event.
Within minutes of the ‘Leave’ vote, almost every chief investment officer, strategist and fund manager sent out newsletters recommending what investors should do next. Yet this is where we all get it wrong.
Just like when Pavlov rang a bell the dogs became hungry, when an event like this happens investors ask themselves and their private banks: “How can I make money from this event?”; and “What should I buy?”
The question, however, should not be about what to buy, but rather about how you are invested, and how this event affects your long-term investment plan (if you don’t have one that’s an even bigger problem).
Investors attempt to trade the market, timing it with the false hope of beating it. But most fail miserably. That’s why a majority of investors under-perform any relevant benchmark you throw at them.
What investors should be asking themselves is: “How am I positioned going forward?”
It’s not about individual exposures within the portfolio; it’s about the long-term position of your portfolio that will really matter.
We are now entering a risk-off environment, and while signs were already flashing (crazy moves in Japanese yen and Swiss francs, increased levels of the VIX index, etc), the Brexit vote may have been a catalyst that starts a longer period of uncertainty and heightened risk.
Alan Greenspan said it best on Friday, in an interview: “Brexit marks the worst period since I’ve been in public service.” He feels going forward will be worse than the 1987 market crash, the Asian crisis in the late 1990s, the dot com bubble of early 2000s, and the global financial crisis in 2008. That’s a bold statement, and shouldn’t be ignored.
Some investors might now be saying something like: “Thanks for the advice, but I can’t close up and hide under a rock, so what should i be doing during these periods of risk off?”
Obviously, the best thing to do is reduce risk within your portfolio. Investors should look to invest in the following: funds with lower betas (not all funds are the same); defensive sectors; strong dividend-paying utility players; low-volatility ETFs; and market-neutral hedge funds.
But, most importantly, investors should do this all at the macro level and try not to pick and choose individual investments which they think will benefit in the short term.
Again, I’m not trying to promote doom and gloom, or advise selling all equities and going into hiding. However, I would suggest that it is time to review your portfolio and position it for the long term, knowing that we may have just entered an extended period of risk-off.