I've been re-reading a few of the columns I have written over the years, focusing on those that look at the older (more experienced) long-term investors in order to try and get an idea of how they handle a crisis filled with severe uncertainty.
In the process I came across an old quote by Warren Buffett in a 1996 annual letter.“What an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
This piece of advice from Buffett apparently originated from a comment by IBM founder Tom Watson, who said: “I’m no genius. I’m smart in spots – but I stay around those spots.”All of this got me thinking about how us long-term investors should manage our portfolios during this incredibly uncertain time filled with a host of unknowns.
The problem is that we know so very little about the Covid-19 pandemic, as all the data we have is less than five months’ worth. If I showed youa company to invest in, and only this amount of data, you’d rightly ask for more. A lot more.
But this is the reality we find ourselves in – we simply have very limited data.This hasn’t stopped many from forming opinions about how we should be responding. But those opinions are largely worthless, especially when they’re actually tainted by broader political and life views. As far as the pandemic goes, I really only listen to epidemiologists – and even they admit we’re working in the dark right now. Any projections are, at best, informed guesses.
But pandemic or not, we’re still long- term investors and we have to make decisions on what to buy, sell or whether cash is the best place to hide.
So, we should start by defining our true "circle of competence" and accepting that, for most of us, that circle excludes epidemiology, which means we're investing blind and will continue to do so for some time - likely well into 2021, if not even 2022.
That brings me to the million-dollar question: How do we then invest when we’re flying blind during the first true pandemic to be experienced in a century?
As I’ve explained in my columns as this crisis has taken over, I’ve been avoiding all individual stocks and only been buying diverse global exchange-traded funds (ETFs). Secondly, as I wrote back in early March, I had a hard look at my portfolio and exited a few positions in stocks I thought would seriously struggle. Now, make no mistake: I underestimated the severity of the pandemic and aggressive selling in more of my stocks would have served me well. But that’s the beauty of hindsight, and it’s of no use to an investor.
What then of the future? I remain very cautious during this uncertainty. Fixed income, such as government retail bonds, remains attractive. (I wrote about this in the 7 May issue, notwithstanding that these bonds’ rates dropped from 11.5% to 10%.)
I’m also looking at structured products that offer 100% capital guarantees, as well as some put options over the Top 40 that will appreciate in value if the index falls. We’ve run hard off the lows from March, and a put warrant such as TOPSBZ* only expires in December and works as an insurance policy in case markets take a turn for the worse during the rest of the year.
The reality is that my circle of expertise doesn’t help me know what the market will do due to the pandemic.So, I’m keeping it very simple by hunting for yield and looking to survive rather than thrive. And buying some downside insurance to further protect my portfolio.