Equities are vital. Market crises are absolutely necessary. But what about now?
Alexander Raviol, Partner and CIO Alternative Solutions at Lupus alpha, had to be ready for anything on 15 March 2020. “On the Sunday afternoon, we sat down as a team and it wasn’t clear what would happen next. The DAX was at 9,000 points and we were running different scenarios, one of which was “DAX at 2,000 points”.” A TED survey revealed that losses began to bite far earlier for most investors, with 56 per cent of respondents recording a 30 per cent correction. More than half of those surveyed believe there will almost certainly be a slump within the next five years.
Despite this, equities remain essential, as Raviol showed with the help of long-term interest rate trends. As cuneiform texts show, loans from 5,000 years ago were subject to interest of up to 20 per cent. Today, 90 per cent of US high-yield bonds are generating losses for investors. What does that tell us? In the last 5,000 years, interest rates have never been as low as they are today. What’s more, Raviol believes that a sharp increase in rates is unlikely despite rising inflation.
This means that interest rates are no longer a reliable source of return. While equity risk premiums remain, a succession of crises pose a permanent risk that looms over the equity markets. How can this potential pain be minimised? Raviol’s strategy is to actively manage a floor value, which has been 90 per cent in Lupus alpha Return since 2007, 90 per cent in Lupus alpha Sustainable Return since December 2020, and 75 per cent in Lupus alpha Equity Protect since November 2021.
Ensuring that the floor value remains reliable is one challenge – and one that Raviol and his team have succeeded in without exception in the case of LA Return. The other challenge is to avoid completely exhausting the risk budget, otherwise you become trapped in a cash lock and cannot participate in the market’s subsequent recovery. “2020 was the perfect stress test for that,” reported Raviol. LA Return reached the end of 2020 with performance of 5.48 per cent, while many other capital preservation strategies could only watch as prices rose. Raviol concluded by saying: “I dare to say that it is possible to use equities to generate attractive returns with limited risk in a world of negative interest rates.”