Couple of risk mitigatation observations in this bear market

After analysing this bear market over the past few weeks the following observations may help you with deploying your savings with a risk mitigating way.

A number of people I know stick to Equities – because that’s what they are most familiar with. Don’t limit yourself to one asset class and consider the track record of other asset classes in stress scenarios including FX diversification. While correlation remains high when market participants liquidate their holdings some may provide good hedges and increase your long term returns. 

1. The worst market volatility is over but further turbulences lie ahead

The initial crash came with forced liquidations from all corners of the market and we witnessed the quickest drawdown in history. While certain strategists (e.g. Morgan Stanley) predict that liquidations are over volatility as defined by the VIX Index is still high. If you managed to avoid the initial crash this may be the moment to start investing but deploy cash on a staggered basis which will help mitigate losses. Remember, that a lot of past bear markets exhibited the following pattern (1) sharp decline – DONE (2) substantial bounce back – TBD if this was the last couple of weeks (3) slower but steady declines before bottoming out – TBD if we get there 

2. A strong USD may help investors but will be challenged in the coming weeks

After initial weakness in USD (classic unwinding of carry trades that benefited the Japanese Yen and the EUR) the dollar has rallied significantly. If you invest in S&P Index or NASDAQ and the market falls further from current levels a strengthening of USD could provide you some natural hedge if your base currency is non-USD

However, investors need to remain cautious given that the virus epicentre will now gradually move the Americas which may slow down or even reverse this trend. When the market turns positive at some point you may even consider hedging a weakening USD if your base currency is non-USD via derivatives or without leverage through ETFs.

3. There is nowhere to hide when high stress builds up but “safe havens” still perform relatively well and offer diversification

While you may expect Treasuries and Gold to provide relief in a stressed environment this has so far not been always guaranteed. In fact, similar to 2008 Gold has periodically declined given that some market participants liquidate their profitable positions to meet margin calls on loss making trades.

Surprisingly short term fluctuations affected other safe havens like the Treasuries since e.g. some hedge funds unwinded risk parity trades. But these have nevertheless fared relatively better than equities and offer diversification. Also, both Gold and Treasuries may benefit from low real rates should the FED keep these low in the near term

4. Fixed Income ETF market has seen some discounts to NAV and wide bid/ask spreads

While the underlying positions in ETFs may not have had any liquidity, ETFs have been more liquid and effectively acted as a proxy of what was happening to the underlying. In that sense, ETFs actually improved transparency to market participants and provide you insights on what is really happening to the underlying

If you are (i) relatively confident about Investment Grade Credit in some jurisdictions and (ii) want to avoid interest risk risk (i.e. short duration ETFs) some high quality Fixed Income ETFs (blue chip names) have been trading with wide bid/ask spreads which meant that you could buy cheaper ETFs taking them from forced sellers where market makers didn’t want to take the risk. 

Beware, that defaults may start materialising and even central bank purchases may not change the fact that Investment Grade credit gets downgraded or get under further pressure. 


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