How Financial Professionals Should View Risk During a Pandemic
The pandemic changed many aspects of life for financial professionals (private equity professionals, investment bankers, and asset managers). Like many, the future of work, the outlook for their career, and their future travel have all morphed. However, working with many financial professionals on their personal wealth management at the height of the pandemic panic led us to reframing risk for their public investments.
During the past decade since the great financial crisis, there has been a lot of great positivity in the public markets. How the industry has thought about risk management as it relates to both human and financial capital has not been tested like we saw in 2020. Below we will walk through what that evolution was and the importance of the reframing going forward.
Pre-COVID Risk Management
Prior to COVID, many financial professionals, like the rest of the industry, thought of their public portfolio allocations in percentage terms (ex: 30% in fixed income and 70% in public equity). This has been the traditional stance of discussing portfolio risk as academic literature commonly used this method to standardize their research. In a normally functioning market, this approach works well as markets generally have their historical correlations, and your human capital can be independent of your financial capital.
Pandemic Risk Management
However, when markets react as they did in February and March of 2020, the percentage terms do not offer any peace of mind when intraday volatility was 5%+ and markets fell the fastest in recorded history. During this time, public markets were in freefall, and many financial professionals started to fear job security. This created feelings similar to the Great Financial Crisis and understandably, fears that their firm could be the next Lehman. During this time, the allocation to fixed income helped to insulate the downside, but what did that truly mean? How was a 30% allocation, for example, going to help calm the fears of financial professionals during this time?
Post-COVID Risk Management
So, how did we start to change the view of risk management for financial professionals after our learnings during the crisis? Well, instead of solely thinking about allocation and risk management in percentage terms, we simply started to think about them in both percentages and dollars. Although this may seem simple, the pivot helped many clients stay in their seat during this time.
Instead of saying a portfolio is 30% fixed income, we urge financial professional clients to convert that into a dollar perspective as well. To continue the example, 30% in fixed income on a $2 million portfolio would be $600,000. Having that knowledge of that amount in fixed income and even converting it into how many years of savings you have in fixed income can truly alter your perspective in the midst of a crisis. This conversion can allow you to focus on your family and career during that time and less on the portfolio.
This simple change in approaching risk management to utilize both a percentage and dollar viewpoint on your public portfolio, especially your fixed income, was a vital change that can allow you to make the right decision in the middle of a crisis. According to JPM, the average investor between 2001 and 2020 annualized a return of 2.9%, while a diversified 60/40 portfolio returned 6.4%. This is mostly due to not making the wrong decision at the wrong time. By applying this new view of risk management, we hope it can help you outperform the “average investor” in the JPM study.
Matt is a Wealth Manager at BDF and leads the Financial Professionals Practice Group and serves as the Director of Client Experience and Growth. He serves as the personal CFO to families, private equity professionals, investment bankers, and asset managers. Matt loves to help make the complex simple and help clients enjoy a full life.