Investors love predictability, certainty and bull markets. However, the global economy is presently characterised by bears and volatility.
While these trends will likely persist for the foreseeable future, many investors are more concerned that the temperamental markets will lead to another incalculable event – a fabled black swan moment.
We asked Investec Wealth & Investment’s Global Investment Strategy Group for their views on how to prepare for future black swans.
Bracing for the next black swan
Between 2000 and 2010, the global economy experienced two such events – the dot-com crash and the 2008-2009 sub-prime financial crisis.
“As a consequence, markets remain acutely aware and frightened of black swans,” believes John Haynes, Head of Research and Chairman of the Global Investment Strategy Group, Investec Wealth & Investment.
These events caught the world’s investment community napping and many investors now expect that something similar is lurking around the corner. “Those of us who lived through both events have our antennae finely attuned to spot another unpleasant event on the horizon,” adds Haynes.
The problem is that by their very definition, black swan events are virtually impossible to predict, states Phil Shaw, Chief Economist at Investec UK.
These abrupt corrections wreak havoc on markets, leaving a wake of destruction in their aftermath. While a few investors were able to spot these black swan events and realise exponential returns, most of the market dreads the possibility.
“However, we can't base investment decisions solely around avoiding black swan events because the opportunity cost is too great – overly cautious investors would lose out on significant market returns. While it's prudent to be mindful of left-field events, a more logical approach is to identify and leverage the factors that precede bull and bear market turns,” adds Shaw.
How do investors prepare for a future they can't predict?
Applying an analytical lens to market data
This requires experience, a keen eye for indicators and, increasingly, the ability to analyse data. However, this raises other concerns, says Chris Hills, Chief Investment Officer, Investec Wealth & Investment UK.
“Relying too heavily on raw data can be dangerous because this approach assumes that the future will follow the same pattern as the past. An investment manager's job is, therefore, to look at all the possible eventualities to make an accurate prediction that protects, insulates or mitigates the risk to investors' funds across a range of possible outcomes, without sacrificing potential returns.”
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Beware the investment jungle
Annelise Peers, Chief Investment Officer at Investec Wealth & Investment Switzerland, describes a black swan as a highly unlikely event with potentially severe consequences.
“But often, other more sinister animals lurk beyond the swans, bulls, and bears. There are two other investment market 'animals' that investors should consider, namely the elephant – something that is often discussed but no action is ever taken about it – and the grey rhino, which is a highly likely yet ignored event.”
In her book titled Gray Rhino by Michelle Walker, the author identifies four kinds of grey rhino events: the charging rhino, something you need to deal with right away; the recurring rhino, which refers to cyclical periodic threat such as inflation or interest rate hikes; a meta-rhino, which is the most dangerous because existing structural issues are not addressed, such as rising debt levels; and the unidentified grey rhino.
“As such, investors must be aware of the broader risk and threat profile that exists in today's global environment,” suggests Peers.
While Haynes believes that defences against black swans have improved and we now have systems in place to scan the horizon for them, investors must remain vigilant. “We’re back to normal cycles, but with an embedded risk premium that rightly reflects our uncertain near-term political direction.” So, tread carefully!