Investors are understandably concerned about the drop in value of their holdings as the first pandemic in many generations redefined our lives, seemingly overnight. HBS believes that investment processes, grounded in understanding the financial markets and the economy, provide the antidote for impulsive investment decisions.
In The Wealth of Nations, a definitive examination of the practical and moral aspects of a market economy in the pre-industrial age, Scottish economist Adam Smith coined the term invisible hand as a guiding principle. Mr. Smith’s explanation of free-market economics in 18th century Great Britain centered on the belief that market participants always act in their own interest. A marketplace of sellers and buyers making voluntary transactions unleashes powerful economic forces — the invisible hand.
In mid-February, approaching the 11th anniversary of the record-long bull market and primarily focused on maximizing returns, investors began to deal with the reality of the pandemic. The coronavirus overwhelmed securities markets. Investor confidence collapsed Feb. 24 when it became apparent the virus had infiltrated the United States.
It is a long-held tenet of investing that markets hate surprises. In the first quarter of 2020, we saw the markets detest the unknown impact of the novel coronavirus on business and the economy. The novel coronavirus was a rare example of an unknown risk — a potential investment loss that is both unexpected and unmanageable. In the economic battle of this war, the invisible virus has temporarily shut down the invisible hand of the economy.
As the magnitude of the public health crisis revealed itself, financial markets sold off dramatically. All of the symptoms of panic were there: illiquid markets, wide bid-ask spreads (absence of buyers) and high correlations across all asset classes (indiscriminate selling to raise cash).
The first quarter performance numbers for fixed income, while generally positive, mask a brief interval of disturbing market dislocation. In an understandable flight to quality, high-quality bonds rallied in February. But on March 10, the bond market abruptly began selling off as the depth of the crisis caused a seemingly universal move to cash. Institutions, individuals as well as public and private sector investors sold bonds to raise the cash deemed essential to ride out the crisis. See Deborah Collins’ related article, In Fed We Trust, on the Federal Reserve’s unprecedented actions to shore up the debt markets. Despite the turmoil on bond trading desks, high-quality bonds (and bond funds) provided a vital cushion to equities within diversified portfolios, including target retirement date funds.
In the midst of such negative market sentiment, it is understandable to be concerned. Policies and past practices remain relevant as we rebuild the economy and markets recover. Given the current state of the securities markets, HBS would like to re-state our investment philosophy—core beliefs that guide us as advisors for your organization’s retirement plan. Process is key to achieving your employees’ long-term goal of an adequately-funded retirement. To be effective, a process must be adhered to as the market traces its cycle.
Process happens at three levels:
- the retirement plan level;
- investment managers; and
- individual Investors.