26 Feb Investing with robo-advisors in times of market stress

After a very calm start to the year, February brought volatility back giving up all the gains of January and more. Fears of rising inflation led to an equity market decline of 6.38% in the first 8 trading days of February, reversing the 5.66% gains that we saw in January. US equities plunged by 4.1% in one day on 5th February, their biggest daily drop since August 2011. As an investor, most of us went through emotions of greed in January and those of fear in February.

Volatile times are the best to invest

While human mind is attuned to loss aversion, such market corrections are an opportunity to build or top up your portfolio.

Bento 60-40 portfolio has managed to tide through the recent market stress very well and in line with our expectations. Year to date we are flat irrespective of the massive drop in equities. Moreover, in this period equities and bonds showed strong correlation. Asset allocation and risk management gains centre stage in such situations.

The off-benchmark 15% allocation to cash and 5% allocation in broad commodities helped cushion the fall. Therefore, the ability to take systematic off benchmark bets to manage portfolio risks is key.

Since going live in 2016, we continued to invest in during Brexit vote, US elections and more recently the volatility that we just encountered.

The objective of this write-up is to reinforce the best practices in investing and discuss how a robo-advisor can help weather such situations and even help benefit from it.

The 60-40 portfolio is up 10.38% net of fees in the last one year.

Algorithm & risk management matters

How your portfolio did in this period largely depends on what drives the performance and construction of the algorithm in case you use automated investment tools. Broadly speaking there are two types of algorithms: (1) rule-based and (2) self-learning, also known as artificial intelligence.

Rule-based algorithms that use fundamental forward-looking data are best suited to weather the unchartered territory of perennially low rates whilst the broad economy continues to grow at an ideal rate of 2% – 3% that we have found ourselves in. At Bento, we ensure data quality that drives asset allocation via our partners like Mercer. We use the same data that influences US$10 trillion of global institutional assets and the portfolio construction tool makes it accessible to anyone irrespective of how much or how little investible assets they may have.

Bento’s algo enabled off-benchmark bets of up to 20% of the portfolio and rotated into value assets from grown one quarter ahead of the crash.

Portfolios managed based on AI have a historic bias built-in and are in principal souped-up mean variance optimisers without much ability or track record to manage investment risk. In such markets, I would watch out for such propositions.

Fear of catching falling knives?

We continue to suggest and implement dollar cost averaging for all portfolios that we manage. As a data point, anyone in the last 30 years invested into global equities for a period of 3 years on an average has made 9.8% per annum and has had a historic probability of 1 out of 6 of losing money. We did a deep dive into this last October. Here is the link to the analysis.

A systematic investment tool such as ours keeps your investment goals and plans on track and far from emotions of fear and greed.

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