5 ways to capitalise on chaos

If it bleeds, it leads. Forgive my crassness, but in journalism, you’ll almost always find the best stories contain conflict. Perhaps it’s also true in markets: as Warren Buffett said, “Be greedy when others are fearful, and fearful when others are greedy”.

Recapping this series, we’ve seen arguably more conflict than agreement among our four respondents. About the only thing they (mostly) agreed on was that we’re in a late-stage, bull market rather than the start of a new one.

But their reasons for this common view varied widely. And on the question of where they’d invest if we, hypothetically speaking, were at the start of a shiny new cycle? Yep, more conflict. Even blockchain and crypto got a look in. Alongside retail and FMCG; industrial metals to play the recovery trade in construction and clean energy.

Now we come to the final question; how should one invest if we're at the end of a bull market? In the following wire, you’ll read five high-quality strategy recommendations, because sometimes it pays to ask the investment experts.

Keep your portfolio diversified

Andrew McAuley, Credit Suisse

A diversified multi-asset class portfolio that can protect from downside risk as well as participate in the upside is always the best protection for an investment portfolio. 

Asset allocation is a bigger performance contributor than any individual stocks or instruments contained within, so getting that right is the first critical step.

As we’re seeing more risks emerging for growth assets, this would normally precipitate:

• A shift from shares to bonds,
• Decreasing Australian shares.

In equities, this would mean reduced exposures to retail and building materials, while favouring more defensive sectors such as healthcare, A-REITs, utilities and consumer staples, in addition to the sectors we outlined above.

For investors who may be expecting a sharp downturn, they could possibly look at increasing their exposure to some safe-havens, such as:

• Unhedged US treasuries
• Gold
• Currencies such as the Yen.

Other options include buying puts and selling calls, as a form of both insurance and income enhancement, but we would recommend seeking advice before using these instruments.

Is TINA here?

Anthony Murphy, Lucerne Investment Partners

We agree that we are currently more likely to be at the end of an old bull market than the start of a new one. For starters, you can tell the market is getting frothy when you again start hearing the acronym ‘TINA’ (There Is No Alternative). TINA represents the view that investors should buy equities, as there is no return on offer in other asset classes.

While we’d agree that the traditional asset classes of equities, fixed interest, and cash are challenged, we’d question whether there are no alternatives out there at all.

Ironically, we think the answer is sitting right there in the acronym itself, in the ‘A’ for ‘Alternative’, a group that offers myriad opportunities outside the traditional asset classes.

Based on our view that the market remains late-cycle, our key focus is on preserving capital and the gains of 2020. Across all asset classes, we highly value flexibility in managers’ mandates in this environment. For example, we have supported Altor Alpha Fund where the manager is able to, and has demonstrated a willingness to, move to cash levels of around 35% to lock in gains after a substantial market rally. Less flexibility in other funds can mean some managers give their gains back as the market recedes.

Another strategy where managers can benefit from more flexibility is a private-to-public fund. Managers in this space can allocate to unlisted or pre-IPO companies and can write terms more in their favour, and exercise more control over timing, than would be typical when a broker runs the deal. In this category, we have recently backed Regal’s latest and final Emerging Companies strategy and Perennial’s Private-to-Public funds.

Another opportunity available in late-cycle markets is to invest in funds that have scope to short sell. Two funds in this category that have performed well for our investors over many years are Bronte Capital and Totus Capital. Both have produced poor periods of late; even more the reason to consider them now given that we’re investing for future returns, not previous ones.

Bull about to hit a wall

Emanuel Datt, Datt Capital

If we assume that the end of the bull market is nigh, we would suggest reducing equity market exposure. We would also be increasing our allocation to high quality, senior corporate debt that generally performs well in downturns. In this scenario, lower-quality credit exposures and hybrids are also preferred, as credit spreads on lower quality instruments tend to expand during periods of market distress.

Although cash is not a popular allocation option, we would definitely be holding a significant portion of cash. We find that investors tend to optimise their portfolios to generate the most “running yield” or cash interest, but ignore longer-term risks. While cash today doesn’t earn much, the advantages of holding liquidity during periods of market stress are generally underappreciated by market participants. The key risk with a cash-heavy allocation is that the downturn never comes, while asset prices continue to appreciate.

"What you own will matter"

Simon Doyle, Schroders Australia

Investors generally still believe that a bear market isn’t likely as Central Banks are committed to supporting asset prices. This point about the commitment of Central Banks is hard to argue against. That said, to the extent that a bear market is facilitated through rising inflation, the ability of Central Banks to provide effective ongoing stimulus will be challenged. This environment will see rising inflation expectations, steeper yield curves and probably higher prices for real assets and commodities. This is probably also an environment where what you own will matter so quality and value will matter.

More generally, we think that investing in this zero or low-rate environment is tricky. Investors have seen equities as the leading alternative to low cash rates, but we believe a better portfolio structure enables investors to benefit from the broader credit universe and assume only a moderate increase in risk without the volatility of equities.

Higher-yielding credit, Asian and emerging market debt and selective opportunities in private markets can help boost returns without stepping too far down the risk curve. As markets adjust in any bear market environment, cash may actually look good relative to many other assets.

Where to now?

There is unfortunately never a simple, single answer to investing. Even if you agree we're late-stage and that the COVID crash wasn't a reset ahead of a new cycle, what you should do next is not straightforward. But there are things to bear in mind, and important, common, themes portfolios should have. Diversification is one, as is an active strategy. But perhaps above all, uncertainty across the board highlights the importance of advice and professional expertise.

Stay up to date with this series

Whether you buy into the bull or the bear argument (or somewhere in between), make sure you "FOLLOW" my profile to be notified of the upcoming entries to this series. In part one the contributors discussed whether they believe we're in a late- or early-stage bull market, and part two discussed the counter-factual to this article; how to invest if we're really at the beginning on a new bull market.