Are You Ready for the Next Crisis?

September 18, 2018  | by Timothy T. Yates, Jr., Deborah Spalding

Investment Strategy

Ten years ago Lehman Brothers failed, representing the largest bankruptcy in history, and accelerating a global financial crisis that would knock many non-profit portfolios backward. This came on the heels of the tech bubble bursting just eight years earlier, which had triggered a painful recession and caused steep losses in equity markets. Investors were essentially hit with two “100-year storms” in the same decade—and had to rebuild. The good news is that markets have been relatively calm since the fall of 2008. The bad news is that another crisis will inevitably upset the financial markets. And so on the 10-year anniversary of Lehman, we should ask ourselves, are we ready for the next financial pothole?

At Commonfund, we are having important discussions with clients on their preparedness for the next crisis. For example, we are working with clients to develop a road map, or “crisis playbook,” designed to help chart what decisions clients need to make during the next crisis. For our clients, there are two types of crises they must prepare for: a market event causing significant losses in portfolio value, and an event specific to the organization, such as steep decline in a key revenue source (tuition, as an example). In a worst case scenario, these two events can be correlated, which makes understanding their interplay so critical in navigating the storm.

Most institutional investors have a strategic policy portfolio and, after a decade of favorable markets, they often say that they take a long term approach and will stick to their policy. But to paraphrase former boxer Mike Tyson, everyone has a plan until they get hit. It is never pleasant to think about negative scenarios, but it is certainly easier now than when the crisis is unfolding. Asking questions as simple as “what are we going to do if our portfolio drops 20%?” can help set expectations that can guide you through challenging conditions when they arise. But it’s important to recognize that there are many layers to explore when creating a comprehensive “crisis playbook”. Many investment committees spend time on the quantitative aspects of scenario analyses and stress testing. But it is also important to ask, “What are the likely behavioral reactions of your investment committee?”

Since we’ve had calm waters for ten years, there’s a good chance that there are committee members who were not on the investment committee the last time a crisis hit, or who have not been through a crisis before. How will those individuals react? How will the group react? Another important consideration is the impact on the broader financial ecosystem, including stress points on other sources of revenue, expenses, and overall operating dynamics. And let’s not forget, it is likely that your constituents will also be in the path of the storm—and it will be important to ask whether their needs may increase at exactly the same time your resources to meet those needs are impaired. In the end, a crisis event will have impacts that extend beyond a drop in the portfolio. The associated effects can be just as challenging, and their impacts can be felt for a long period afterward.

It is also important to keep in mind that doing nothing during a crisis is itself a decision that may influence the portfolio’s ability to recover to pre-crisis levels. As the chart below shows, rebalancing to policy target following a sizeable downturn in equities may help boost long term investment performance, even beyond the historical average. And potentially, it can be more difficult, if not impossible, to recover without taking some type of action.

CH1_SP500_Subsequent_Returns

Asking these questions can be an effective starting point to creating a framework for your crisis playbook. This playbook can serve as a roadmap to guide you when the storm is at its peak, visibility is low, and tensions are high. At a fundamental level, you will need to decide if you are going to stick with your existing strategic policy, if you are going to reduce risk in your portfolio, or if you need to cut or increase spending. While these questions seem basic, they are important to ask today, as your answers can have long term, significant impacts on how you navigate the next crisis, and the degree to which you recover…or not.

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Authors

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Deborah Spalding is Deputy Chief Investment Officer and a Managing Director responsible for the design, tailoring, and implementation of custom investment solutions for Commonfund’s investment advisory clients. She is primarily responsible for asset allocation recommendations, portfolio oversight and analysis, and tactical rebalancing of client portfolios. Prior to joining Commonfund, she was the Chief Investment Officer for the State of Connecticut’s $30 billion Retirement Plans and Trust Funds. Previously, she was a Managing Partner at Working Lands Investment Partners, LLC, an independent investment management firm that invests in rapidly growing environmental markets. Prior to that, she held a number of executive level positions including Executive Vice President and Head of International Investments for Schroders Investment Management N.A. and Managing Director and Head of International Institutional Investments at Scudder Kemper Investments. She began her career as an equity analyst at SKB & Associates in San Francisco. Deborah received a B.A. in International Relations and Asian Studies from Tufts University and holds graduate degrees from Harvard University, University of California Berkeley and Yale University. She is a past Board Chair and a member of the investment committee of the National Wildlife Federation, and an advisory board member of the Center for Business and the environment at Yale and is a Lecturer in Forest and Ecosystem Finance at Yale.
Deborah Spalding
Deputy CIO and Managing Director, CFA
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Timothy T. Yates, Jr. is a Managing Director and responsible for custom solutions for clients across public and private markets. In this role, he leads a team of investment professionals that advise, implement and monitor custom investment solutions. He is also a senior member of the firm’s private emerging markets portfolio leadership team with a particular focus on Latin America. Tim joined Commonfund as an associate in the Commonfund Capital Associate Program. He later joined the Strategic Solutions Group, Commonfund’s OCIO platform, where he was responsible for the design, tailoring and implementation of total portfolio solutions. Before joining Commonfund, Tim was an instructor of Spanish and Italian at Fordham Preparatory School. He holds an M.B.A. in Finance with a designation in International Business from Fordham University and a B.A. in Modern Languages from Trinity College. Tim is also a member of the investment committee for St. Paul’s Church in Fairfield.
Timothy T. Yates, Jr.
Managing Director

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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.