Portfolio Management During Crisis Periods

Global and local economic crises can arise due to various factors such as debt crises, liquidity crises, inflation shocks, and geopolitical tensions. The 2008 global financial crisis, the 2020 COVID-19 pandemic, and the geopolitical tensions after 2022 are recent examples of such crises.

Global and local economic crises can arise due to various factors such as debt crises, liquidity crises, inflation shocks, and geopolitical tensions. The 2008 global financial crisis, the 2020 COVID-19 pandemic, and the geopolitical tensions after 2022 are recent examples of such crises. During these times, volatility in financial markets increases, asset price fluctuations intensify, and investor confidence weakens. In such an environment, portfolio management strategies gain particular importance. The portfolio manager’s role is to protect capital while developing strategies that ensure sustainable returns.

According to Markowitz’s Theory, which forms the foundation of classical portfolio theory, it is possible to minimize risk through asset diversification. However, developments in past crisis periods have shown that diversification alone is not sufficient. The reason is both the breakdown of correlations between assets and the irrational choices made by investors during crises. Studies in behavioral finance have also shed light on irrational tendencies during crises, such as panic selling, excessive risk aversion, and herd behavior.

Effects of Crises on Portfolios

Increased Volatility: In times of crisis, weakened investor confidence and fear lead to significant spikes in volatility. This results in higher option premiums and risk premiums. Fear indices such as the VIX can also experience sharp increases.

Breakdown of Correlations: Assets that typically show low or negative correlations may move in the same direction during crises, supported by liquidity effects. Portfolios built on historical correlations may fail to provide expected protection under such conditions.

Liquidity Risk: Loss of investor confidence and heightened uncertainty can trigger sudden waves of selling. In markets with insufficient liquidity, asset prices may drop well below their fair value.

Portfolio Management Strategies During Crises

Asset Allocation and Diversification: The most crucial strategy for capital preservation in crisis periods is asset allocation and diversification, which can be categorized into three key approaches:

• Investing in Defensive Sectors: Sectors such as food, healthcare, and essential consumer goods are less affected by economic cycles and experience relatively stable demand. These sectors often come to the forefront during crises.
• Alternative Investments: Precious metals (especially gold) and commodities can play an important role in protecting capital.
• Geographic Diversification: Particularly during crises triggered by geopolitical events, some regions are affected more than others. Investing across different regions can help protect capital.

Hedging and Option Strategies: To ensure capital protection, put options, volatility-linked contracts (such as those tied to the VIX), and inverse ETFs can be employed.

Dynamic and Tactical Management: Reshaping the portfolio dynamically according to changing market conditions is recommended during turbulent times like crises. Tactical portfolio optimization, which involves including alternative investments as correlations shift, can help safeguard the portfolio.

Crises and Opportunities

The most challenging aspect of crises for investors is their tendency to make irrational decisions driven by emotions. Panic and fear-based actions often lead to losses and exacerbate market fluctuations. For investors unprepared for heightened volatility, crises can result in severe losses. However, they can also create major opportunities.

Past crises have shown that asset prices can fall well below fair value, creating significant opportunities. The 2008 global financial crisis and the post-COVID-19 period are prime examples. For instance, the S&P 500’s two-year average returns after crises were 18% following 2008 and 22% after COVID-19.

Applying the right strategies during financial crises enables investors to minimize losses while also capitalizing on opportunities created by the turmoil. Investors should be prepared for different market scenarios and always have alternative plans in place. Being ready for various scenarios helps prevent emotions like fear and panic from distorting decisions and allows investors to turn crises into opportunities.

Managing your investments with confidence, diversifying your portfolio, and minimizing risks is most effectively possible with BV Portfolio’s expertise.