Crisis management: how to tackle black swan events

Crisis management: how to tackle black swan events
Staying calm in a crisis is hard. Here’s how a $2bn investor managed it, twice.
Dan Lane
February 4, 2022

March 2020 will live long in the memory.

Stock markets across the world plunged on the outbreak of the pandemic and prompted commentators the world over to crack open the history books. Was this another 1929? How about a return of the millennium bust? What about 2008?

It turned out to be a completely different beast but, as we hopefully near the end of it all, as investors we need to learn from the whole thing rather than just consign it to the history books.

That’s something Freetrade’s head of equity research Paul Allison has experience in, having already gathered a few battlescars investing through the global financial crisis in 2008, as well as the tumult of the past few years.

We sat down with Paul to talk about how investors can stay calm in the face of uncertainty, how to make sure you’re ready for volatility and how a fund manager overseeing $2bn in client money keeps a cool head when the market is losing its own.

Paul, how did you get into investing in the first place?

I started in the industry in 1999. 

My friend had worked as a summer intern for a large investment house and he got me a job as a fund manager's assistant (FMA). These days an FMA role leads onto a trainee fund manager programme. Then it was really mostly about opening mail and booking trades. Keep in mind most fund managers didn’t have PCs or email so there was a lot of mail to open.  

After a year or so of working quite closely with some high profile fund managers and thinking to myself that they looked to be having fun, I decided I wanted to have a shot at it myself. So I applied for some grad jobs in the city and landed one in 2001. From there it was about exams and on-the-job learning. I was given a decent amount of responsibility from a relatively early age - that’s the best teacher. 

Do you have an investing style?

Yes, I’m a quality investor. That means different things to different people but what it doesn’t mean is just buying famous companies. It’s probably easier to start by understanding what quality investing rules out. 

Any company whose fortunes are heavily impacted by something beyond management’s control or external influences that are highly unpredictable would not be a quality investment.  

I have no idea what the price of copper or oil is going to do. Nor do I really know what’s going to happen to global economies. So I try to avoid the companies that are reliant on those types of influences. 

It took me quite a long time to develop this style but it is very much aligned with long-term investing.

When trying to identify quality investments for the long term you’re looking for predictability of profits, whether there is enough runway for growth, and crucially a high return on capital.  If you can find all that and not have to overpay then you could be onto a winner.  

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What have been some of your big wins and losses over the years?

I have friends and old colleagues who are unbelievably skilled at picking stocks that have loads of upside. They do mountains of insane analysis and come up with profit forecasts that are twice what a bunch of Wall Street analysts at large investment houses think. 

I’ve never been any good at that. My best investments have been where I've identified a business demonstrating the criteria I mentioned and held on for the long run, allowing the stock to compound solid long-term returns. Often these stocks (if you get them right) do way better than you originally thought and it is worth holding on for many years.  

I think Warren Buffett said the best holding period is forever and most of my best investments were exactly like that.  

On the other side, my worst losses have been selling too early, as opposed to buying things that have bombed. My style hopefully avoids that for the most part.  

My biggest mistakes have been thinking I was smart after a stock has done well and selling because I thought it was too expensive.  There is an old saying that you don’t get fired for taking profits. Really that's nonsense. 

Selling great companies too early means that you can miss out on some of the incredible success that they enjoy in the future.  I sold all my Amazon holdings in 2014 thinking it was too expensive, for example. I bought it back a few times but it doesn’t disguise the mistake of thinking that the stock was too expensive when I sold it.   


What happens in the mind of a professional investor when the market drops?

Keep in mind that most professional fund managers that practice long only investing (i.e. not shorting) are measured against an index like the S&P 500. If your fund is positioned defensively because you have somehow predicted the impending doom then when markets fall you will do relatively well.  

Your performance might be bad but it won't be as bad as the S&P 500. So oddly you’d be doing quite well on a relative basis as markets fall. If, on the other hand, you are underperforming the index the pressure can be intense.  It feels particularly painful if you are underperforming a declining market because you know that your clients are losing money. 

During crises, like the global financial crash or the pandemic, your relative performance doesn't matter, and the fate of humanity can play on your mind instead.  

It sounds like hyperbole but I remember walking home from the office early in 2008 after watching markets collapse 10% and feeling sorry for people because they weren’t aware of what was to come.  

Obviously this is massively melodramatic, and in hindsight things are never as bad as what they seem in the heat of the moment, but being consumed in markets does sometimes give you a bit of a crystal ball as to what lies ahead.  

During the pandemic collapse we were sent in a bit of a hurry to work from home like everyone.  I was sitting in my bedroom with a laptop, using an ironing board as a desk and watching my funds lose around $200m.  It was sobering to say the least.      

What are some of the most common mistakes you’ve seen investors make during crises?

Speaking for myself, the biggest mistake I have made during panicked times is listening to other people.  

This flies in the face of a lot of advice and of course novice or non-professional investors should always seek financial advice if they aren’t comfortable making their own investment decisions.

But if you are used to making decisions on your own as a professional investor, when things go wrong and you start drafting in the opinions of other people you can lose your compass.  

You might be speaking to people you trust but if you don’t speak to them every single day there is no way of knowing if you have caught them on a bad day or a good day, and like it or not that affects their mood and their outlook on things.  

Working in a team is different because you know those people intimately and know how to read their moods. When you’re making decisions on your own it’s fine to seek other views but be aware that they may not be the same from one day to the next.  

Do you think it’s easier or harder being a fund manager or retail investor in those instances?

Honestly, it's probably easier being a retail investor as there is no pressure to beat an index.

Often keeping it simple is the best thing to do and fund managers sometimes tie themselves up in knots trying to be smart. This is especially true during times of panic and the pandemic was a great example.  Instead of getting too bogged down with complex analysis, it paid to take a step back and just think from first principles.  

‘If we are all going to be spending way more time at home, then Netflix should do well’.

Obvious right? Yes it was and for a while Netflix stock was amazing. 

As a fund manager, there is also the pressure of having to beat an index and knowing that over time more people don’t do that than do.   

What are your top tips to keeping a cool head when the market drops?

Stay optimistic.  

Markets fall and it's part of investing, I’ve been unfortunate enough (or fortunate, whichever way you want to look at it) to experience two crises.  During the pandemic I panicked and bailed out on some good companies quite near the bottom of the market.  

This is in spite of 20-odd years’ experience and telling myself repeatedly to not panic.  I also made a point of advising less experienced members of the team to stay calm and not panic.

So why didn’t I listen to my own advice?  I don’t really know but I do know that I wasn’t optimistic when I bailed.  I think I thought that people's habits would change forever and that we would never travel again and all the rest of it.  

Ironically there was some truth to my thinking, but markets recovered dramatically anyway. Rightly or wrongly, had I stayed optimistic I wouldn’t have bailed out at the wrong time.  More often than not we find a way to muddle through.  

Have you ever had a stock show you why that’s important to keep in mind?

Yes, before the pandemic I had done a fair amount of work on Live Nation, which is a concert promotion and venue business and was a decent size position in my fund.  

When news of the pandemic broke my initial reaction was to use weakness to build a larger position as I had a strong view that the pandemic would blow over in short order and we wouldn’t be talking about it by the end of the year.  

My logic was sound and was based on what had happened in recent history with SARS and MERS.  I couldn’t have been more wrong about the impact and duration of the pandemic, but ironically I was spot on with regard to the stock.  

Live Nation went from $75 to the low $20s and is now around $110.  I’m not sure exactly at what point I decided that we would never attend concerts again but I sold quite close to the bottom.  It's an example of being caught up in the negativity at the wrong time.  

As an experienced investor I know that it is always darkest before dawn but sometimes emotions just get the better of you. Oddly enough I was taking action around some narratives I didn’t believe, and still don’t. 

I don’t believe that city life is dead and that we will all want to live in the suburbs. So I held onto a position in Outfront Media, which is an out of home advertising business with lots of exposure to large cities like New York. 

I guess the major lesson here is about consistency.    

We always hear it’s best to fix the roof when the sun’s shining - what are some things investors can do ahead of any market turbulence?

It's a great question and one that is difficult to answer.  My best tip is to get yourself into a strong enough position where you can do nothing.  

If you’ve built a diversified enough portfolio of good companies then trying to predict and time markets is generally not a good idea.  If things are going well then don’t tinker.  You could probably say the same for when things are going badly.  I tried to fix my portfolio at completely the wrong time during the pandemic crash.

There are times when I had strong conviction of pending corrections and took action to buy defensive companies, like consumer staples, but there are plenty of other times where I have had the same feeling and been wrong.  I have taught myself to ignore the impulse to make changes based on some macroeconomic view.  If you get it right you can feel very smart but the likelihood is you wont time it perfectly.

Past performance is not a reliable indicator of future results.

Source: Koyfin, as at 31 Jan 2022. Basis: bid-bid in local currency terms with income reinvested.

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