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COVID’s Impact On Global Markets, Lessons For Asset Managers

Charles Paikert

29 April 2021

COVID-19 dramatically affected markets and proved to be a shock to systematic risk, according to Toby Moskowitz, professor of finance at the Yale School of Management.

The pandemic had a “clear affect” on equities and asset allocation, according to Moskowitz, who spoke at the Investments & Wealth Institute’s ACE Academy conference.

When COVID first struck last year, it quickly altered the correlation structure of major asset classes, said Moskowitz, who is also a research associate at the National Bureau of Economic Research and a principal at AQR Capital Management.

Over the next several weeks, “there was no place to hide from COVID,” he explained. “The market understood what would happen and anticipated that it wasn’t going to stop. Every asset class was exposed to the COVID factor.”

After analyzing high frequency data and global asset returns, and tracking global news about the pandemic, Moskowitz and his team found “the biggest change in correlation structure in the past decades.” 

In addition to “massive allocation shifts,” volatility also spiked dramatically, the research confirmed. 

How should asset managers react in a crisis?
So what could asset managers have done? Could they have hedged their risk exposure to the crisis?

In a word - No.

“There was nothing you could do about it,” Moskowitz said. “If you tried to predict it, you would just make things worse. It was the very definition of a crisis - there was nowhere to run and hide and no way to hedge it away.”

COVID was indeed a big crisis, which Moskowitz defined as a common risk that is unavoidable. But what markets experienced during the past year’s pandemic holds true for all major crises, Moskowitz asserted.

“COVID was a microcosm of how asset allocation behaves during a crisis,” he said. “There will be a next one, we just don’t know what it will look like. But we can learn a lot from this one.”

COVID lessons
What are those lessons for asset managers?

“Diversification is still your best bet,” according to Moskowitz. “Despite the fact that the benefits of diversification were a lot smaller during the pandemic, long term you will be better off.”

The key for asset managers is getting through a crisis without succumbing to pressure from clients to tinker with portfolios by hedging or trying to mitigate losses. Attempts to gain back losses during a crisis are likely “to make matters worse rather than better,” according to Moskowitz.

Instead, asset managers should make sure that they are diversified across asset classes, markets and factors, and ride out the storm. 

And in the case of COVID, the market distortion was relatively short-lived, underscoring another one of Moskowitz’s research findings - just as the market quickly anticipated the pandemic’s severity, it also predicted the economy’s recovery.

“Diversification never guarantees you won’t have losses,” Moskowitz said. “In fact, you will have losses, especially during crises. But if you can stomach the losses and have good risk management practices in place, portfolios can be poised to benefit when the market rebounds.”

Risk management practices should include cutting trading, reducing exposure and limiting the impact of the crisis, he said.

The more effective asset managers are in instituting procedures and policies that maximize their chances of living through the crisis, Moskowitz concluded, the better off they will be.