2020 isn’t even halfway over but it has already been a year for the record books. We saw the stock market register its fastest and steepest decline from a high, ever. Only to follow that up with its swiftest and strongest recovery of all time. Revisionist history suggests that in 5-10 years most investors will remember themselves navigating the 2020 crash in a much different manner than they actually did. In the spirit of transparency and self-reflection, we thought it would be a good opportunity to discuss some of the things we did as investment managers during the market crash. So in this article, we’ll conduct a self-interview and analyze what we did well, what we did just okay, and what we can improve on for next time.
Responses marked DC is from Donald Cummings Jr, the founder and CEO of Blue Haven Capital. Responses marked KK is from Kevin Kleinman, who has been a Financial Advisor with the firm since 2017.
What did we do well?
Q) What is one thing you feel you did really well during the market crash in March?
KK: I think I did a really good job communicating with clients, both prior to the actual crash and on an ongoing basis as it was happening. I regularly send out client updates during periods of heightened volatility, and in late February I warned clients to expect continued volatility for the foreseeable future. Now, I certainly didn’t tell them to prepare for a 30% drop over three weeks. But as it became clearer and clearer that this drop was not going to be “normal,” I ramped up the communication. General client letters turned into individualized emails, phone calls, text messages, etc..
I feel that I grasped the concept of the crash meaning different things to different people. For some, it was an opportunity, for others it was the scariest thing they’d ever experienced. This emphasis on communication helped me better understand how to manage each client’s individual account. And as a total result, I can honestly say that not one person panicked. That’s not to say people weren’t nervous, they were (and so was I), but I never had one “sell everything!” phone call. And I think that’s a credit to the clients we attract, but also to the fact that my communication style, at least partially, prepared clients and helped them build a little immunity to dramatic headlines and market swings. So when we did discuss things like raising cash, these were logical conversations that usually ended with not selling anything, or raising about 5% in cash.
DC: I believe we had portfolios set up within the risk tolerances that clients were comfortable with. In the old days (20 years ago or so!), we’d often use something called “Monte Carlo Simulation” to estimate what a portfolio would most likely look like with a 40% down move in stocks. More recently, we would discuss what a 40% down move looked like, ie, a $1mm portfolio that is 60/40 means 60% of that $1mm is allocated to equities. If equities fall 40%, that means a loss of $240k….and a slight gain in the 60% bonds. We’d ask “How do you feel about a $1mm portfolio going to $760k or so?”. I think most people were prepared emotionally for that sort of scenario, whether they were 80% stocks or perhaps 20% stocks. Also, we began using buffered ETFs in portfolios in late December/early January. These certainly helped protect some positions against downward moves.
What did you do okay?
Q) What is one thing you did just okay, not too good but not too bad?
KK: I think I did an okay job when it came to tax-loss harvesting, which proved to be a big value add given how much the market has bounced back. However, all of my tax-losses were focused on equities. I should have also reviewed my bond holdings for tax-loss harvesting opportunities as well, specifically in high-yield. HYG, a high-yield corporate bond ETF we own, was down 20% at its March low. That would have been a great time to harvest tax-losses and swap into a competing fund like JNK. So when it comes to tax-loss harvesting, I think I did some good things, but looking back, I could have done even better.
DC: I believe the allocation into buffered ETFs at the end of 2019 and beginning of 2020 helped, but looking back, we should have been far more aggressive with using those types of funds. On the allocation of cash, we chose to invest over time (a period of 8-12 weeks) when of course the thing to do would have been to buy heavily when the market was down 35% or so. However, when a portfolio moves from $1mm to $650k, it is very very difficult to put even more money into stocks when behind the scenes, there were credible rumors of a complete world-wide market collapse.
What do you wish you did differently?
Q) What is one thing you wish you would have done differently and can improve upon for next time?
KK: This is a two-part answer but the basic premise is opportunity cost. There was a lot of it for me as a result of a couple of strategies I use. First, my use of buffered ETFs, which helped limit losses during the downturn, cost me gains on the upswing. One huge thing I will take away from this is that buffered ETFs are great vehicles for allocating to the market when you think it is high, like in January, but not after a huge drop like in March.
After the 35% drop in the S&P 500, I should have been swapping out of those buffered ETF products into uncapped index funds. This would have served a dual purpose: 1) allowed me to tax-loss harvest losses from the buffered products and 2) pocket a difference in losses of what would have been 10-20% losses in some buffered ETFs while buying index funds that were down between 30-50% between S&P 500 and Russell 2000 ETFs. So there was definitely some opportunity cost by not executing that type of trade.
Improving the allocation strategy
Secondly, dollar-cost-averaging did not prove to be a good strategy once the market bottomed. While some of this reflection can be attributed to hindsight bias, it also revealed a true error in my strategy. I typically follow a two-pronged dollar-cost-averaging approach, either by time or by price. For example, I might allocate 15-25% of available cash once per week over a period of 4-6 weeks.
However, my strategy allows for two allocations (or more) to be made in one week if the market is in a continual free fall. For instance, if I buy on Monday and then the market falls another 3% by that Wednesday, I would then make an additional allocation instead of waiting for the next week. This proved to be very effective for a client who just so happened to get started with me during the first week of March. I ended up making seven weeks of scheduled allocations in less than seven trading days. In essence, I was “buying weakness.”
Buying on the way down versus on the way up
But the strategy cost me when the market bottomed and started going back up because I didn’t have an established process for “buying strength.” I was either waiting for the next week in my schedule, or the next 3% dip. So while I am proud to say I was actually buying stocks on March 23 (the exact bottom for the S&P 500), I am embarrassed to say that many of my next buys then weren’t until 10-20% higher! That’s because from March 23-April 17 the S&P 500 rallied 31%, and only experienced one 3% dip (on a closing basis)! Because I was waiting for a scheduled dollar-cost-average date I missed opportunities to buy more at even better prices.
As a result of this experience, I’ve been reviewing my allocation strategy in great detail and considering what changes to implement. My ideas have centered around dollar-cost-averaging versus lump-sum investing, reviewing client-by-client timelines more carefully, and/or buying into strength. I haven’t yet finalized how I am going to improve my allocation strategy, but it is my top priority going into the third quarter.
Bonds were the real worry
DC: Following along with my above commentary, I believe we should have run numbers for a market collapse in all securities simultaneously, not just stocks. Certainly, stocks were in the news daily because many large-cap indices fell as much as 35%. However, the more complex and worrisome collapse was in bonds.
Bonds and hybrids (preferred stocks for example) fell over 40% due to a lack of liquidity in the financial system. Municipal bonds went from trading at approximately 80% of the yield of Treasuries to trading approximately 300% of the yield of Treasuries. Many municipalities that wanted to issue bonds for projects like water system improvements had zero bidders for their bonds. Banks ran into balance sheet problems and mortgage companies couldn’t finance their new or refinanced mortgages.
Behind the scenes of a much-noticed stock market collapse were the rumblings a financial system meltdown that was so complex, that it often did not make the news. I experienced the 1987 crash, the tech collapse in the early 2000s, and the market collapse in 2008. They were nothing like what I saw this time. I believe that moving forward, when running client risk tolerances, that we should look at across-the-board, simultaneous market drops of 45% and then structure portfolios accordingly. This will drop anticipated rates of return, but it will also reduce portfolio volatility.