Background 

2020 has been a challenging year by any measure, with the effects of the COVID-19 pandemic driving financial markets up and down on an unprecedented scale. The Dow Jones Industrial Average (DJIA) reached an all-time high of 29,568 in February 2020, but in March, when the pandemic started to hit most countries, markets plummeted rapidly. Reaction to the pandemic triggered several trading curbs (also known as circuit breakers) in the United States, and a general sense of fear, uncertainty, and loss of control. 

The unprecedented situation caused by COVID-19, with travel and large gatherings out of the question, was still not enough to stop the 73rd CFA Institute Annual Conference from taking place. CFA Institute ensured everyone’s safety by bringing the three-day conference online, and by extending participation to a much broader audience around the globe. I was able to listen to leading researchers and investors share their views about the impact of the pandemic, and dispense valuable advice for living and working through the global crisis. While most of the conference participants described the markets as “tumultuous” and “unstable,” many still carried a positive attitude. Here is a recap of the three-day event and the key takeaways.

Day One (May 18th): Economic cycles and predictions of recovery patterns 

In a presentation entitled “Global Economic Risks and Rewards,” Alejandra Grindal, senior internal economist with Ned Davis Research, described the global economy as being in its deepest recession of the post-war era, with many services abruptly halted. She emphasized how “no country has been left unscathed by COVID-19,” but believed the shape of the recession and its recovery path will vary by country, as follows:

• North America: U-shaped or square-root–shaped recovery in the U.S., depending on the controlling of the virus, the effectiveness of the stimulus packages, and the permanence of the temporary job losses (although Canada was not specifically addressed in the presentation, we may anticipate a U.S.-like recovery shape here, due to the close economic ties and trade relations between the two countries)
• Eurozone: U-shaped recovery, due to early signs of flattening in the COVID-19 curve, but downside risks continue to exist
• U.K.: U-shaped or W-shaped recovery, depending mainly on the consequences of Brexit
• Japan and China: Square-root–shaped recovery, due to quick containment of the spread of the virus

Grindal concluded by saying that “global slowdowns are associated with equity drawdowns,” suggesting that technical indicators may signal the bottom before global recessions are over.

Day Two (May 19th): Stress management for investment professionals 

Daniel Crosby, chief behavioural officer with Brinker Capital, delivered a presentation entitled “How Psychological Principles Can Help You Think and Act Your Way through a Financial Crisis and Personal Stress.” Stated Crosby, “The COVID-19 pandemic is unique in that it threatens our physical, psychological, and financial well-being.” 

Crosby then shared his key to stress management:

• Own your stress and recognize it. Do not be judgmental.
• Remember the importance of “non-identification,” which means you are not what you’re feeling.
• Investigate the sources and find the solutions, providing the example of a three-step process: 

– First, begin with the “why” to restate the purpose. Ask questions like “Why do I need to analyze this particular feeling I am having now?” and “Why does this pertain to a potential bias in my decision-making process in managing investments?” 

– Next, proceed to showing the “what.” Look for evidence of whether the emotions are rooted in fear, lack of control, overwhelming uncertainty, et cetera. 

– The third step is to develop a process of overcoming stress, which is the “how”: “Can I identify the biases I may have?” “Are there mental exercises I can take to overcome stress?”

Crosby ended the presentation with encouraging evidence from the past, giving plenty of reasons for hope. Historical returns for SARS, MERS, Ebola, and swine flu were “double-digit positive,” and history indicated, he said, “improved forward return probabilities from six to 14 percent.” 

Day Three (May 20th): Investing in an unstable environment 

The tumult in the equity markets led many investors to question whether value investing worked anymore. The short answer is yes, it still works, according to Aswath Damodaran, a professor with the Stern School of Business at New York University, and who has taught about discounted cash flow (DCF) models for many years. 

But while the value investing model still works, Damodaran said, “difficult times require dynamic models, where forecasts of the past are not anchored in past numbers.” Damodaran explained that mechanical models, which many DCF models have become in practice, will yield strange-looking numbers. What has stopped working is the valuation method of “downloading last year’s financials for a company into a spread-sheet and then using historical growth rates, with some mean reversion thrown in, to forecast future numbers,” he said, adding, “it is precisely at times like these that you need to go back to basics.”

Damodaran urged updating the value drivers, which are revenue growth, operating margins, growth efficiency, or investment efficiency. All of these required new assumptions and forecasts. Similarly, the cost of equity will also be different—and probably higher—as investors demand higher risk premiums. In the end, the DCF model should take into consideration the “failure risk”—the chance of a catastrophic event that puts a company’s business at risk. 

How can asset management firms adapt to the new market conditions? Katherine Nixon, chief investment officer, wealth management with Northern Trust, answered this question well in her talk “Asset Allocation for Private Clients: Lessons Learned amid Stressed Markets,” where she discussed a purpose-driven asset allocation methodology.

All assets serve a purpose, whether it is purchasing (home, automobile, travel), education, inheritance, or philanthropic legacy. The risk then becomes the assets “not funding my goals,” and so the client’s goals directly inform how portfolios are constructed. A portfolio should consist of two portions: risk control assets and risk assets. The “portfolio reserve” is a core and critical concept because it directly informs risk control assets available to fund core lifestyle goals during periods of market stress, and should contain a low volatility source of funds. “Understanding the number of years in reserve to weather market downturns can be a more intuitive way to evaluate portfolio risk and volatility,” said Nixon. “A longer reserve holds more assets in risk control” to sustain the portfolio in a longer downturn. 

Nixon concluded by summarizing the approach’s benefits: the purpose-driven asset allocation methodology is a “framework for informed decision-making,” helping to instill higher client confidence in the construction of the portfolio, while the asset manager can still identify and optimize planning opportunities. 

Summary

The three days of the conference went by quickly. I was impressed with how the investing community came together and shared solidarity, knowledge, and experience in a time of crisis. The conference was a showcase of the CFA community’s thought leadership on a broad range of topics, from economic analysis and investing techniques to mental well-being. As Prof. Damodaran’s former student, I was pleased to see how, after many years, he still diligently advocates for disciplined valuation as part of his efforts to better the industry.

The 73rd CFA Institute Annual Conference concluded on a positive and hopeful note.
Participants agreed the world was in a time of crisis, but that this crisis would bring us a unique learning opportunity, along with a chance for the CFA community to continue to demonstrate leadership, a high standard of professional excellence, and a strong commitment to shaping a brighter investment future.