COVID-19 ‘ALL-WEATHER’ INVESTMENT STRATEGY- IMPLEMENTATION
Context
After having cycled the world over the past 12 months (c.15 000 kms across Oceania, Asia, North America and North Africa — see my IG link in the footer if interested) COVID-19 forced me to make a break in Morocco. The health situation worldwide is already very difficult. The economic reality is adding to the stress. Market seem to be disconnected from reality (see this excellent take on this fantasy world here) which makes the situation even more confusing. How could a COVID-19 ‘all-weather’ investment strategy work?
Could I ‘lock-in’ passive income while focusing on health, family and more important issues? Can I invest while not having to look at the markets everyday? More importantly, can it be done so that I don’t have to predict which way the market will go this year? I wanted to spend some time to help investors on how to relatively conservatively deploy their savings for long term returns by limiting downside risk.
Objective
You may start your reading by going though the 10 rules to deploy savings in a bear market.
The analysis below elaborates on the actual implementation. It does not take into account prior holdings and focuses only on deploying savings during the Coronavirus bear market. As such it needs to be analysed in the wider context of your personal objectives, risk tolerance and investment horizon. The analysis and numbers are illustrative ONLY and have the objective of providing a framework of analysis only.
I have already implemented a variant of this strategy in parts of my personal portfolio a couple of weeks ago after the initial c. 35% drawdown in the S&P 500.
Scenarios
The way I thought about the current investment situation is to assume three potential scenarios for COVID-19 ‘all-weather’ investment strategy:
Base Case
To stay on the conservative side I assume that the current rally is a bear trap that will ultimately reverse. It is likely that the S&P 500 will drop to 2,500 or may retest the lows of March 23rd. Ultimately, I assume that base case goes as low as 2000 points for the benchmark Index. It would recover in the second half of the year. This is in line with a number of Wall Street strategists and shouldn’t come as too controversial.
Optimistic Case
This is not a bear trap and market will consistently rally. While I assign a lower probability to this scenario than the Base case it remains a plausible path forward. It can’t be ruled out that one of the c. 700 studies currently performed on COVID-19 will result in the following: (i) a cocktail of medications containing the disease (ii) or/and a successful vaccine on an accelerated timeline. Note, that the market always discounts these events much earlier than the economy. E.g. Friday’s rally partially on the back of Gilead study (even if this proves too optimistic the point is that we may be getting much closer to something that works)shouldn’t come as too controversial.
(Extreme) Stress case
This scenario assumes that the S&P drops to 1600 points and subsequently recovers. This broadly assumes medications are not successful in the short term. Or/and FED liquidity injection / bridge is not enough and reopening of the economy is a failure (aka multi round — ‘no single round’ which the FED is betting on as per game theory). It may result in massive bankruptcies and potential depression. I don’t even want to think about the ramifications of this scenario, hence I won’t elaborate here.
Analysis
Assumptions and Limitations
For sake of simplicity I assume to have max. 130k USD to deploy for long term returns
- This serves only as illustration to show that there are effective strategies for long term returns assuming one has a tolerance for short term losses
- In these hypothetical scenarios loss rates range from 22% to 31%
- This strategy is based on S&P levels and NOT deployment of capital through regular time intervals. Time interval investing is another way of deploying capital that is not illustrated here
- It has the disadvantage that capital is not fully deployed in Base and Optimistic scenarios — one would need to make additional assumptions here
- However, it has an advantage of partially protecting you from tail risk should the S&P move sideways in the medium term and then plunge. This is essentially why I use this strategy as I always then to remain on the cautious side
- I invest in ETFs to reduce idiosyncratic risks
- Assumes one would have already deployed capital so that at current S&P levels (2850) 60k of the funds are invested in the S&P 500
- For simplicity and to be extremely conservative I assume the S&P recovers to c. 3,400 points over 36 months
- The S&P ‘5k top ups’ are somewhat arbitrary and depend on where you would assume large buyers will come in (resistance) and likelihood of scenarios and thresholds
- Balance is ‘replenished’ at these levels based on periodic losses
Illustrative Results
This is a very simplistic analysis but shows that an ‘All-weather’ portfolio is feasible:
- Returns range from c. 20% to 47% depending on scenario
- I also have some minor allocation to stocks I consider offering a very high risk/return profile and oil but for simplicity this is ignored here
- I am also not going into the fact that you can diversify and get different indices. E.g. could get more defensive initially with NASDAQ but when a certain level is hit assume that tech will ‘catch up’ on losses of other industries etc.
Happy to share the sample sheet of this COVID-19 ‘all-weather’ investment strategy. If you would like to adapt this further — please subscribe to the newsletter to get a copy!
Stay safe and healthy!
As a reminder — the views expressed here are my own personal views. The above is a simplistic generic scenario analysis. The information provided is general in nature only and does not constitute personal financial advice. You should consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate.
