Ensuring a portfolio has enough liquidity to rebalance back to the long-term strategic asset allocation is the most critical preparation investors can do ahead of any crisis, according to Mark Wiseman, a former global head of active equities at Blackrock and chief executive of Canada Pension Plan Investment Board.
“What you need to do is ensure you always have sufficient liquidity to rebalance your portfolio,” he said in an interview.
“That is the critical preparation, so you cannot just rebalance but take advantage of the liquidation. Rebalancing is critically important and goes to the maintenance of your long-term risk appetite.”“If you have 60 per cent allocated to equities, what has changed in your long-term risk appetite because of this pandemic? Nothing. So investors should be religiously rebalancing as equities markets fall. As they recover, you should be selling and buying fixed income to bring the asset allocation back. If you don’t have the liquidity to do that you’re in deep trouble.”
Wiseman, who is assisting the Canadian government with its response to the pandemic, said that investors should always be asking whether they have sufficient liquidity to rebalance in even the most extreme circumstances – “Whether it’s an oil shock, a war, a pandemic or an asteroid invasion,” he said.
During his five-year tenure as chief executive of CPPIB, the portfolio would be automatically rebalanced if the allocations moved more than 0.5 or 1 per cent outside the target weights.
“It’s important to have automatic rebalancing of your portfolio to your long-term risk as soon as you slide outside of those weightings,” he said. “Long-term risk for most investors doesn’t change. Markets were down 4 or 5 per cent today. Do your long-term risk rankings change because of that? No. Then you should be buying equities today.”
There are some noticeable examples of pension funds rebalancing recently. David Villa, CIO of the $117 billion State of Wisconsin Investment Board said he was a “fearless rebalancer” at the moment. And the $58 billion Pennsylvania Public Schools Employees’ Retirement System (PSERS) recently sold $1 billion of US Long Treasuries in order to rebalance.
Chief investment officer of PSERS, Jim Grossman, said the investment team would rebalance asset classes back towards the board’s strategic asset allocation targets as deemed appropriate and the changes are done at the staff level per existing policies.
“All rebalancing decisions are made with the primary goal of ensuring our system maintains enough cash and liquidity to get through this storm. We are succeeding,” Grossman said. “We sold $1 billion of US Long Treasuries after other investors looked for safety in bonds. That run into the safety of Treasury bonds caused yields to fall fast and prices to rise, which in turn pushed PSERS’ allocation of US Treasuries above our target allocation for that asset class. We sold Treasuries to raise liquidity and get back to our 6 per cent strategic target allocation.”
According to Wiseman, who was also formerly chair of Blackrock Alternative Investors, there is no risk system used in investments that would have predicted this event. “You can’t use BARRA or some other risk system and expect this scenario to come out of it. No one thought in our lifetime we would see this,” he said.
However, he said all long-term investors should be testing their portfolios using scenario planning for these types of events.
Wiseman, who also sits on the board of Sinai Health in Toronto, did a full study and scenario planning for the impact of a pandemic on the portfolio at CPPIB.
“For long-term investors in particular these are the types of scenarios you should be running and looking at how it affects markets and businesses,” he said. “While you can’t predict them, you should know they can come around. You should be thinking these types of scenarios are possible. Does that mean you change your risk appetite? the answer is no in my view. But you need to always know that they will occur you just don’t know what flavour.”
Keeping a long-term perspective is important, he added, pointing out that at CPPIB the mantra was that a quarter was defined as 25 years. “If you have that perspective you’ll be around long enough to see the mean reversion that inevitably takes place after these events,” he said.
A recent Wall Street Journal article, co-authored by Wiseman and Sarah Williamson, chief executive of Focusing Capital on the Long Term, an organisation he co-founded and used to chair, looked at the market recovery around the global financial crisis, September 11, the 1918 health pandemic and the oil shock.
“If you look at a chart of the Dow Jones over 100 years you don’t see any volatility,” he said.
Wiseman added that there is little use in tail hedging strategies for long term investors.
“There’s no point putting in a tail hedge. It’s just like hedging currency if you have a long-term view. It just creates a cost with no expected benefit other than smoothing. And what would you hedge against? You don’t know what will show up.”
Tactical positions can work, he said, but need to be considered in the same context as any active decision.
“You can allocate a certain amount of your risk to TAA, but that’s the same as making decisions around securities, if you have skill in that then allocate some of your risk to that,” he said. “I see CIOs making tactical decisions like overweighting equities by 5 per cent, those decisions are so large in terms of the portfolio they swamp all other decisions. They should be considered as an allocation to an active strategy the same as an allocation to real estate or infrastructure or public equities. I’ve never been a big believer in it. I’ve never been good at it. But I think there are people who are good at it.”
Opportunity of a generation
While it is still early days in terms of how the impact of the coronavirus will play out, Wiseman’s view is there will be a tremendous amount of distress.
“This could be an opportunity of a generation,” he said, pointing out that this time the crisis is not a problem with the financial system. “History says when these things pass people will go to restaurants, cinemas, theatre, watch sport. Six months after 9/11, an event where it was unsure if people would fly again, passenger travel was back to where it was before the event.”
In this case, he says the opportunity will be in the real economy assets that will revert.
“A friend in the music business is signing every band he can find, people will go back to concerts,” he said. “In the short term I’m pretty gloomy, it’s pretty depressing. A lot of people are going to die, there will be massive deficits and we won’t be going out for a long time. But ask me what my time frame is for investing?”
“That is the time when everyone else capitulates and thinks the world will never come back, that’s the time you want to be the buyer, because it will. Stick to your long-term course, and be the buyer when no one else is. If you retain your risk appetite you understand you can still take risk.”
Wiseman, who left Blackrock in December, said he had “a few irons in the fire” and was likely to return to asset management sooner rather than later.