Rather than attempting to dodge the next crisis, investors should accept the inevitability of market shocks and focus instead on controlling volatility, according to hedge fund CFM.
Speaking to InvestorDaily, CFM president Philippe Jordan said approximately 400 crises have affected financial markets since 1971.
In addition, once a decade there is a crisis that directly affects market infrastructure and results in volatility jumping by five to seven standard deviations overnight.
"We know just by looking at the past that crisis is the de facto operating code of markets and societies in general. They are not the exception, they are the norm," Mr Jordan said.
The best way to adjust to the once-a-decade crises, he said, is to adapt to the new risk environment, become more defensive, and then eventually put risk back on.
"But there are hundreds of pseudo-crises that you’re supposed to do something about, and doing something about them is precisely the wrong thing to do – it’s reactive," Mr Jordan said.
CFM attempts to build portfolios that are agnostic to crises, he said. To achieve this, the hedge fund has three 'siloed' portfolios: one with a positive skew to investment markets; one with a negative skew; and a market-neutral portfolio.
"We try to optimise our chances to have a coherent portfolio through the next 400 crises that are going to occur over the next three or four decades," Mr Jordan said.
Investors have a tendency to focus on 'pseudo-crises' such as Brexit, which he referred to as "known unknowns".
"It’s one thing to predict the outcome of the referendum and say it’s going to be ‘leave’," Mr Jordan said.
"You then need to figure out the inferences, the corollaries that will actually impact financial markets and your portfolio in a meaningful way.
"In other words, just predicting an event is not sufficient. You need to predict the corollary effects of the event. Doing this on a repeat basis over time is improbable," he said.
By maintaining a constant level of risk within its portfolios, CFM avoids the need to make "snap decisions", according to Mr Jordan.
"We’re not in the history business; we’re in the input/output [business] – maximising outcomes per unit of risk exposure to markets. That’s our business," he said.
CFM made its Institutional Systematic Diversified Fund available to Australian institutional investors in 2014. The fund is now available to retail investors via Colonial First State’s First Wrap, Netwealth, HUB24 and Powerwrap.
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