Investing During a Crisis – Offence or Defence?
Sudharshan Sathiyamoorthy, Ph.D., MBA, is Vice President and Chair of the Investment Committee for Richter Family Office (RFO). Sudharshan heads up external manager due diligence efforts and evaluates traditional and alternative investment strategies before they are presented to the families with whom RFO works. With a wealth of experience finding unique opportunities and ensuring they are carefully vetted, he’s no stranger to evaluating a range of strategies while always considering the big picture in all economic climates. Here he lends his insights to investing in this current climate.
When trying to make sense of current events, it’s natural to look back and search for similar occurrences in the past. In recent history, when we think of ‘economic crisis’ our minds automatically circle back to 2008. But, the 2008/9 crisis was different from the current crisis. While the former had its roots in the financial industry, with banks and other market participants being overleveraged, and homeowners owning homes that they couldn’t afford the mortgages on, this current pandemic has its roots in a health and human crisis, that has led to both a demand shock (people in lockdown are not spending), and a supply shock (with businesses shut down, supply chains are impacted). Thus, despite any seeming similarities, the simple truth is that “this time it’s different”.
While some countries are relaxing the lockdown measures the fact is, no one knows how things will evolve – there are many unknowns, and right now, there are more questions than answers. What will the psychological impact on society be from prolonged social distancing? Once found, how long will it take for a vaccine to be broadly and readily available? Will there be a second wave of infections as countries slowly re-open their economies? Will there be more “working from home”? Will more people drive instead of using public transit? What additional interventions will there be from governments and central banks? With so many unknowns, and with no clear timeline for a resolution to the crisis, it is only natural that fear and panic can set in, not only in everyday life, but also when it comes to markets and investing.
If panic is in the air, should we liquidate all investments and stay in cash?
Philosophically, there is no such thing as a “free lunch”. You need to take risk in order to make returns. As humans, we have a natural instinct to “run from pain”. However, to paraphrase the legendary investor Warren Buffet, be greedy when others are fearful, and be fearful when others are greedy. It is often during crises and other distressed events that market dislocations occur, and for an investor who is ready to capitalize on opportunities during these times, there can be great rewards to reap.
So, should we be thinking defensively or offensively?
The short answer is both. First, let’s speak about the defensive part. If you were overly exposed to equities, or cyclical industries going into the sell-off earlier this year, then it would have been very difficult to curb the negative impact to the portfolio during the downturn. The problem is that when markets sell off, volatility increases, and liquidity disappears. What this means, in simple terms, is that buying protection for your portfolio becomes very expensive and selling positions will result in poor prices because there are no buyers or very few buyers.
The defensive stance to a portfolio must be in place before any crisis occurs. This is where an RFO professional can help. We work with families of significant means to understand their unique challenges, needs and aspirations. With this in mind, and based on their cash flow needs, we construct a bespoke portfolio for each family. The portfolios are not only diversified across asset classes, but include growth, income, and defensive focused components. For instance, we recently presented an opportunity to our families with a lower middle market direct lending manager in the US. This investment, as an example, has fared well during the past few months because of the manager’s focus on lending to companies with low leverage, long operating histories, well-aligned management, and in industries that are recession resilient such as health care and business services.
When markets are panicking, it’s crucial to have an established process to rely on; one that maintains discipline, and allows for an orderly, calm, and thoughtful approach to move forward. During the downturn, our team reached out to the various managers our families are invested with, to get a better understanding of the impact to portfolios. Though we subject managers to a rigorous due diligence process prior to allocating capital to them, the ongoing monitoring we undertake, especially during stress events, gives us additional information on the managers’ abilities to act as prudent fiduciaries for our families. This in turn, will inform our views and impact our level of conviction with the managers.
Having considered the defensive aspect, how about playing offence?
At RFO, we have access to some of the largest asset managers and most well-respected investors in the world. To get greater insight into what was happening as the crisis unfolded, we tapped into our global network – including not only hedge funds, venture capital funds, private equity and private credit managers, but also sell side research arms of investment banks, peer investors, and other market participants. What we learned is that the opportunity set has, and is, morphing. Initially, some of these opportunities were fleeting. For instance, much of the panic selling in equity markets has now been retraced, and investment grade spreads that widened to high yield levels narrowed when the US Federal Reserve and other Central Banks announced intervention efforts. However, there remains much opportunity, especially in credit markets. The initial opportunity was created by distressed investors – there was a sudden need for liquidity, and anything that was able to be sold, was sold. This resulted in “the baby being thrown out with the bath water”. While this opportunity is less readily available now, the focus has now shifted to stressed assets (companies that might, for instance, not have enough liquidity on their balance sheet to weather the crisis). In the coming months, as defaults and bankruptcies increase, the emphasis will shift from stressed assets to distressed assets. As we emerge from the crisis, the opportunity will once again shift to finding ways to help companies re-open, re-start supply lines, and re-hire the workforce required to operate and become profitable once again. At RFO, we are actively engaged with managers who can take advantage of these current and future opportunities that are arising from this crisis.
That sounds optimistic! Do you have any final thoughts?
In terms of investing, this can be viewed as an exogenous ‘bump in the road’. At RFO, we are with our families through the best of times and the worst of times. We strive to create portfolios that are durable, and that have sustainable and repeatable return characteristics. Our ongoing monitoring ensures that when managers are no longer able to maintain the function they serve in our families’ diversified portfolios, we will look for a better alternative. And most importantly, we focus on months and years, as opposed to days and weeks. We humans, as a species, have an incredible ability to be resilient and persevere. I have no doubt that as they say, in time, this too shall pass.