May 07, 2020

How to Manage Risks in Your Portfolio During A Recession

Russ Zalatimo
Written by: Russ Zalatimo
Alternative Investment, Syndicate and Investment Banking

Manage Risk During a Recession

The chance of a US recession in 2020 was about 20% when the year started. According to Bloomberg, that chance has increased to 100% since the coronavirus outbreak began rocking world markets. Furthermore, Morgan Stanley and Goldman Sachs believe we’re already in a global recession right now. Read below to learn how to manage risk during a recession.

The record-breaking 11-year bull run—which many thought we’d be able enjoy long into the foreseeable future—is officially over. It ended the moment the indices fell 20% from February’s highs and stayed there. As of May 6th, the Dow Jones has dropped more than 35% below its February peak, but has bounced back significantly during the recent bull run.

 

How bad is the 2020 bear market?

This eye-watering market nosedive broke a number of records, including the four worst single-day point drops in US history (since February, we’ve experienced 7 of the top 10 worst single-day point drops), as well as the single worst weekly drop ever.

 

Needless to say, this is unprecedented territory. Even Warren Buffett, who grew up during The Great Depression, admits he has never seen anything like this in 89 years. Amid such carnage and gut-wrenching volatility, what is the regular investor to do?

 

The good news is that even though this has been a record-breaking market crash, it still follows many of the same patterns that previous corrections, bear markets, and recessions did. Consequently, there are several ways you can protect your portfolio and hedge your bets against further drawdowns.

 

1. Lower risk, long-term: Buy and hold defensive stocks

As of March 20th, the world is effectively shut down. China and Italy are still under quarantine, while the UK, Germany, and US have closed bars, restaurants, and other public gathering places. People have been asked to stay at home unless they work at an essential store like a pharmacy or supermarket.

 

In uncertain times like these, buying defensive stocks can help reduce your exposure to risk. The types of defensive stocks you want to buy depend on the situation. In our current coronavirus-triggered bear market, lots of people are stuck at home with nothing to do.  

 

Consequently, defensive stocks for our current bear market may include:

 

  • Businesses that are considered essential, such as utilities and consumer staples  
  • Businesses that may experience a surge in interest or demand, such as delivery and streaming services (and even biotech firms searching for the vaccine)
  • Businesses that may not be drastically affected, such as technology stocks that make most of their revenue online.

As an example, Modern (MRNA), which began Phase 1 vaccine trials, hit all-time highs a couple months ago. Walmart (WMT) also reached all-time highs around the same time. And Netflix (NFLX) has weathered the storm far better than the rest of the S&P 500 so far.

 

2. Take higher risks in the short-term: Go long or short volatility

If you have a larger appetite for risk, the volatility indicator (VIX) is usually the best play during the first sharp crashes of a recession. In 2008, VIX shot up from about 15% to an intraday high of 96% less than 1.5 months later. Notably, volatility wasn’t at its highest at the bottom of the recession: that happened in March 2009. But by the time we got there, VIX had fallen back to just 55%.

 

Why was volatility lower when the market was at its bottom? Because volatility is based on daily percentage swings. The VIX is range bound between 0% and 100%, and spends most of its time between 10% and 20%. During a sharp market crash like the one we are now experiencing, volatility can surge beyond 80% for a short period of time. In fact, this time around, volatility has already surpassed its 2008 peak.

 

It’s important to understand that most recessions tend to follow a pattern. Historically, after the first sharp drop, bulls will try (and fail) to rally. This is when the second, slower breakdown occurs. It takes longer and has smaller daily swings. As a result, volatility may peak during the first sharp drop and swing back and forth at lower values until the market bottoms out. During the recovery period that follows, volatility continues to decrease while the bulls regain lost ground.

 

Simply put, volatility can be a very good play—but only if you’re familiar with VIX and how it moves during the different phases of a bear market or recession. It’s certainly not for risk-averse investors. But for those who embrace risk, there are several volatility ETNs to choose from.

 

3. Help mitigate risk in the long term with alternative investments

An alternative investment is an asset that does not fall into conventional investment categories. Conventional investments include stocks, bonds, notes, and cash or cash equivalents. Alternative investments, on the other hand, include things like real estate, hedge funds, private equity, venture capital, pre-IPOs, commodities, futures, derivatives, and even art.

 

Because there are so many different types of alternative investments, they are often attractive options for defensive investors seeking to diversify their risk.

 

Unfortunately, most investors have little to no access to alternative investments due to the multiple barriers to entry. Funds, private equity, venture capital, and pre-IPOs tend to have very high buy-ins, which means you’ll need to be an institutional or accredited investor. Real estate and art are often very expensive as well, but can be smart investments during a recession, as the 2008 recession taught us.

 

Fortunately, advisory firms like ours offer investors easier and more affordable access to alternative investments, giving investors the opportunity to purchase uncorrelated assets that do not move in tandem with the markets. This democratization of once-restricted assets has led to a “resurgent demand in alternative investments since 2005, according to McKinsey.

Learn More About Alternative Investments

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Now is the time for wisdom

It’s normal to be anxious, nervous, or even downright scared right now. Even the most grizzled Wall Street veterans are unnerved by what’s happening.

In the face of such unprecedented volatility and uncertainty, every investor needs to rethink tried-and-true investment strategies. What worked during our 11-year bull run will not work right now.

It’s time to consider the investment strategies that paid off during the last recession. Which ones will you embrace?

 

 

Past performance does not guarantee future results.  This is for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation of any products or services.  Opinions are subject to change with market conditions. The views and strategies may not be suitable for all investors and are not intended to be relied on for legal or tax advice.  Please note that any investment involves risk including loss of principal.
Alternative Investment Funds represent speculative investments and involve a high degree of risk. An investor could lose all or a substantial portion of his/her investment. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment in an Alternative Investment Fund.

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