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Cope With COVID Via Rules-Based Investing

Todd Schwartz, November 6, 2020

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There's a saying "discipline equals freedom", and maybe this applies to financial market investing as much as other walks of life. COVID-19 has created turmoil, forced massive change and closed down large chunks of the global economy. Investing in such a world requires rules.

The following article comes from Todd Schwartz, regional partner at Concurrent, an advisor-owned partnership of independent advisors affiliated with Raymond James Financial Services. He writes here about approaches to investing in a world pushed around by the COVID-19 pandemic and the associated clampdowns by governments from Asia to North America. Markets are famously driven by "fear" and "greed" - according to one popular trope, and the virus has certainly done a lot for the fear side of the equation. How best to operate in this environment, and to remain poised, alert for opportunities and be disciplined? Schwartz aims to answer those points below.

As ever with guest articles, the usual editorial disclaimers apply. Jump into the conversation! Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com


There’s no doubt that 2020 has been a year unlike any other. The COVID-19 pandemic has claimed more than 200,000 American lives, forced countless businesses to close and sent the stock market on a wild ride. Using the S&P 500 as an example, which hit a new high in late February, dropped by more than one-third (more than 1100 points) before rebounding to a new all-time high on September 2. If nothing else, this year has demonstrated how important it is for advisors to expect the unexpected.

With my own clients, I stress the importance of having an investment framework that provides the basis of a 10-year investment plan. That plan is not something carved in stone but rather a fact-and rules-based approach that can be used in the face of any situation that may arise. For investors and their advisors, the most important thing is to have a process and stick to it. Without a disciplined process, too many variables are left to chance which in turn can lead to dramatic underperformance.

The reality is that where most investors fall short is on having a consistent process. They react emotionally to short-term changes in the market or socio-political turmoil, which can do long-term damage to their portfolios. That’s what I see as the problem with an outcome-based approach to investing, which in my experience rarely leads to long-term quality performance. Investors who focus on chasing returns do not possess the discipline to hold onto a rules-based strategy during times of market change.

Delbar’s Quantitative Analysis of Investor Behavior research shows that when an investment vehicle is outperforming, it attracts more assets and conversely, when underperforming it is subject to more redemptions.

This approach amounts to basically chasing after last year’s hot managers and hoping that they can deploy all the new capital they’ve attracted and continue to outperform, and then moving on to the next hot manager or investment when the tide turns. It’s a recipe almost guaranteed to lead to underperformance over the long-term.

An investment framework?
Think about your own investment process as an advisor. What investments do you track? How are decisions made? Do you have a strategy and a rules-based approach? Do you have a process and the discipline to stick to it?

One of the greatest flaws in modern asset allocation and current portfolio management is the inability of investors to recognize when risks are higher or lower than normal. Understanding the stages of the market cycle and having the wherewithal to follow a rules-based approach and knowing when to implement, when to increase or reduce risk, are deciding factors in achieving risk-adjusted outperformance over a full market cycle. Outperformance over a full market cycle is not a guessing game, but rather a matter of rules-based investing and mathematics.

If you lose less or, better yet, make money when it matters most, then the math fully supports outperformance. Especially, if you make your returns without leverage or shorting the markets. Timing markets is extremely difficult in any strategy. However, we do need to be able to recognize the long-term trend and phase of the market cycle, and that is where rules-based investing comes into play.  

Consistency, discipline, and patience trump timing in the end. Understanding what strategy makes the most sense for each client is critical. Moreover, staying the course over a full market cycle is paramount in achieving long-term financial success. The rules-based process must supersede the short-term outcome to achieve full market and long-term outperformance with full risk mitigation.

Although the momentum had been building for some time, the pandemic has stepped up the pace of a new “paradigm shift” affecting financial advisors and their investor clients. The norm of traditional asset allocation portfolios is nearing an end. The mix of higher and lower quality bonds that made up a significant portion of many portfolios, may no longer be appropriate or welcomed by investors in a near zero rate environment.

Traditional risk assessments will need to be reevaluated through the lens of whichever phase of the market cycle we are in based on history, coupled with rules-based modeling to account for the real risks which investments carry.

Behavioral finance studies have shown that failing to understand risk causes investors to make moves at the wrong times leading to sluggish returns and underperformance relative to a benchmark.

The world of investing is changing. We, as advisors, can choose to follow the data and embrace rules-based investing and real risk mitigation or pretend that what we are experiencing is normal and traditional asset allocation is still the way of the future, in spite of all the new and relative facts.

About the author
Todd Schwartz is a Regional Partner at Concurrent, an advisor-owned partnership of elite independent advisors affiliated with Raymond James Financial Services, Inc. He specializes in risk management, customized investment management and comprehensive financial planning for both families and businesses.




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