How extreme volatility impacts investment decisions

Carsten Mumm, Chief Economist and Head of Capital Market Risk Analysis at Donner & Reuschel shares some of the steps his firm took when faced with free-falling markets and the lessons learnt for the future

clearpat POSTED ON 10/6/2020 4:18:50 PM

Sara Benwell: How has the recent market volatility impacted your investments and your wider business?

Carsten Mumm: The speed of the market conditions was absolutely unexpected and that is why this market phase is really a test of resilience for our own investment process and for the industry as a whole.

We had some difficulties in implementing our portfolio transactions because there were unusual things i.e. very large opening gaps from one day to another, or lower liquidity in some asset classes like certain segments of fixed income.

"In the future, there will be a larger focus on diversification "

We have experienced an event that no one has ever experienced before. A global pandemic, global shutdown and a recession that was mainly manmade by politics, and this is why this is the ultimate test of resilience.

In the future, there will be a larger focus on diversification and assets with lower liquidity because they haven’t got as much volatility.

Sara: Do you feel that this could be a turning point for ESG where it is no longer seen as an alternative strategy and starts to become more of the mainstream and an expectation from clients or investors?

Carsten: There will be a shift in focus when you look at the concepts of environmental, social and governance.

In the last years, people looked at the environmental aspect but now the social and governance aspects will become much more important after this crisis.

Sara: In these times of market disruption, what are some of the challenges to effectively 1) protect investor and investment performance (risk-adjusted returns?) and 2) Increase the frequency of client communications

Carsten: One of the most important challenges during this market collapse was that we had a totally new fundamental input factor.

No one had the development of the pandemic and the number of new infections as an input factor in their investment processes.

We saw a completely unprecedented answer of fiscal and monetary politics, with huge rescue operations and liquidity injections, which also created a huge investment challenge.

"We saw a completely unprecedented answer of fiscal and monetary politics"

I feel that there were more opportunities than challenges when thinking about client communication.

On the one hand, we saw that we were able to use these wide spread possibilities of digital communication channels so we produced Vlogs, which are short videos, on a daily basis in order to inform our customers or third parties about what was going on in the market.

We published them via social media channels or sent the information to our customers by email. I see this is a great opportunity and feel that it will be a lasting development.

We had to focus on digital communication channels in this pandemic, but we will probably be using these communications in the future.

"We had to focus on digital communication channels"

It is a very special situation when communicating with private clients, because they sometimes had a high personal risk of infection or they were very concerned about their own health and the health of their families, so it wasn’t as easy for them to put their full attention on financial matters.

What we realised is that it is much better to be discreet and let them know that they can come to you and you are available if they have any questions but that we will continue to manage their capital as normal without bothering them with too much information or too many questions.

Sara: What are 2-3 key lessons learnt from the pandemic that will help you strengthen the resilience of your operating environment?

Carsten: The key lessons for everyone during this crisis has been a lot of new experiences and this is important, especially for younger people, who perhaps weren’t in business during the last great financial crisis, or who haven’t experienced the burst of the technology bubble, or something similar.

These new experiences are something they will be able to use in the future.

The danger after each crisis is that you focus too much on this specific situation and if everyone wants to perform better whenever the next pandemic comes.

"We also learnt that market volatility can always exceed the limits that we have seen in the past"

It might be a problem because there will definitely be a new one in the future, with a high probability it won’t be triggered by a global pandemic but by some other difficulty.

We also learnt that market volatility can always exceed the limits that we have seen in the past and the next severe market correction will probably be triggered by another unforeseeable event.

To make it more concrete, there will be a higher focus on diversification in the future, which means diversification amongst asset classes and a lot of people, especially institutional clients, will have a larger focus on non-exchange traded assets because they haven’t got such a high-priced volatility.

"There will also be a stronger focus on single stock selection"

There will also be a stronger focus on single stock selection because, particularly after this crisis, we have seen a different situation between winners and losers.

You are able to use this differentiation by doing single stock selection rather than buying ETFs.

After market conditions everyone will try to adjust their processes, but we will see that in the coming months and years not everyone will be able to do that in a sufficient way because they will lack the required skills and capacity.


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