The Coronavirus has vividly demonstrated that a financial crisis can strike at any time, and come seemingly out of nowhere.
For the Chinese this has to be particularly poignant. As the virus struck, just about the time of the Chinese New Year. The most celebrated time of the year for that nation.
And especially ironic, is that this year is the year of the Rat. Considered to be a sign of wealth and surplus. Unfortunately, that doesn't look to be the case this year.
Since the outbreak of the Coronavirus, just a couple of weeks ago, the Chinese Authorities have carefully managed this epidemic. Quarantining entire cities, limiting travel, and closing the stock market for an extended “holiday.”
For investment professionals this presents a particular challenge. Like any investor, they must decide whether to hold on to their current positions, or to sell. Whether to maintain their current course or correct to a new direction.
Now, as I've observed before, individual investors often have more flexibility than do professional investors. For instance, assuming that you own a position in Chinese Stocks, as an individual, you are perfectly free to sell that position at any time.
But for professional money managers, running a fund of Chinese Stocks, selling out is not an option. They must work out a strategy both to adhere to their fund's prospectus, which outlines what the fund must hold while minimizing and suffering from the decline of the Chinese Markets.
Now over the weekend, the London Daily Mail was able to catch up with Dale Nicholls, who manages the China Special Situations Fund for Fidelity Investments.
This may get a tad complicated: Fidelity Investments is, of course, the giant Boston based mutual fund company. In this case, Mr. Nicholls manages a British based mutual fund, China Special Situations, sold to British citizens. This fund is not offered in the United States.
OK, with that disclaimer out of the way.Nicholls is faced with all the issues that we've outlined. His fund must hold the bulk of its investments in Chinese securities. Chinese markets are likely headed lower. How does he protect his investors?
He outlines three different strategies that he is adopting. And something to consider when we are caught in a similar situation.
His first, move it to sell the weakest sector of his portfolio. For Nicholls that would be the consumer discretionary. This makes perfect sense, consumer spending in China is liable to take a dive. Especially when you consider how many are currently under quarantine. So sell the sector that is likely to get hurt the most.
Nicholls second move, it to hedge his position. China has options, and perhaps inverse funds, which will benefit as prices decline. The most widely followed of these, are Puts on a given market or sector. Puts rise as prices decline. Although it is unlikely that he can use a lot of Puts, fund regulations usually limit this kind of speculation. Nonetheless, Puts, or inverse securities, should help soften the blow of lower markets.
Finally Nicholls is rotating out of the weakest sector in the market, and into a sector, he feels will perform much better. In this case, he is moving into Chinese Technology Companies. The thinking here is that technology is less dependent on the Chinese consumer and more able to take advantage of international markets that are not affected by the Coronavirus.
So there you have a pretty much, “by the book” strategy of an investment manager working to protect a portfolio in a declining market.
First, sell your weakest sector, that part of the portfolio most likely to really hurt you on the decline.
Second, if a unique short term strategy is available, like speculating in Puts or Inverse Securities, consider taking advantage of that.
And finally, move the portfolio into areas that are less affected by the particular crisis. In this case move away from Chinese consumers, who are unlikely to be out shopping, and into something that can take advantage of another type of market. Technology in this case.
It's not going to be easy, but we wish Mr. Nicholls well.