Business man money from rain problem

How to build a defensive portfolio based on 3 criteria that can survive a Black Swan event

Christopher Ng
Christopher Ng

Investors were taken by surprise on Monday 9 March 2020 when the STI dropped 6%. The market collapse was a shock even for a trainer who survived the Great Recession of 2008. Markets were already reeling from the COVID-19 situation, so no one could anticipate the breakdown of OPEC+ that led to a crash in oil prices. It was a perfect storm involving multiple black swan events happening at the same time.

The response from mainstream media and the financial blogosphere was swift. Still, it betrayed a lack of an ability to come up with a coherent response – pundits are either rehashing timeless investing ideas like focusing on value and cash flow without acknowledging that the situation has changed or reminding everyone that markets will recover one day. It is not too bad to keep spirits, but a more coherent response needs to address still works in such trying economic times.

In a situation like a change in economic fundamentals, quantitative models tend to breakdown, and the ERM portfolio predictably lost money. Hard hit as we were, the defensive nature of our investments allowed us to roll with the punches losing 6.65% when the STI ETF lost 11.76% in 2020.

YearDividend PortfolioSTI ETF
2018-5.75%-4.15%
2019+24.28%+8.78%
2020-6.65%-11.76%
Overall+9.35%-7.99%

Now, more than ever, we will need to go further than the usual quantitative models to determine the step forward. To be different from other articles written to make sense of the world economy, I intend to follow these rules to try to figure out what we can do next. The principle would be to avoid talking up single stocks that survive the downturn. Instead, we want to make decisions about the markets that perhaps reflect timeless principles rather than exploit the peculiarities of a particular stock.

So I will find a portfolio that has done relatively well in 2020 and explain its creation. Finding one bright spark in this chaos will, at least, provide one data point on how to proceed forward for investors trying to figure out what to do next.

Fortunately, I do have one portfolio that did relatively well so far in 2020.

On 2 December 2019, I opened a Supplementary Retirement Scheme (SRS) account to optimise my taxes in 2020 which led to a $15,300 portfolio that is too small to mirror my more considerable ERM stock holdings. So instead of following the usual quantitative financial models, I simply used my intuition to build a seven-stock portfolio. As tax savings were already substantial, I just needed to focus on overall defensive quality along with ease of administration.

As it turns out, this was the bright spark I was searching for:

Year7 Ronin PortfolioSTI ETF
2019+1.41%+1.14%
2020+1.11%-11.76%
Overall+2.53%-10.75%

The biggest tragedy of this portfolio is that I relied wholly on my investor instincts to build it. The value is too small compared to the money that I manage, and the tax savings made it unnecessary to optimise it further.  The stocks are like the Seven Ronin, masterless Samurai that no one really gives a shit about, but rallied together to rescue a village.  What I did have on my side is that I spend a lot of time behind Bloomberg terminals and read so many analyst reports that I don’t have to spend too much time coming up with seven counters.

The downside is that we may have to reverse engineer my investor instincts to make a guess what portfolio tends to do OK in a Black Swan event.

Let us look at the Seven Ronin in my SRS account:

If you are the kind of investor that prefers to examine individual stocks, then look no further than looking at data-centre REITs as well as Netlink Trust as defensive counters to hold or shore up your margin account in these trying times. These counters have held onto gains through-out this period.

At the broader level, we may be able to derive these principles on how to build resilient portfolios that can potentially survive a major black wan event.

#1 Resilient portfolios have a Low Beta

What jumped right at me when I tried to do a post-mortem is simply how stable the collection is. A typical ERM portfolio is durable with a beta coming in typically at 0.5. While I did not create this portfolio with an explicit intent to keep betas low, somehow my investor instincts must have kicked in to do that.

#2 Resilient portfolios produce high yields

In a downturn, dividend portfolios tend to do better than growth portfolios, but this is scant comfort. Empirically, you should expect to lose 80% of what other investors lose when you tilt towards higher yields.

The current dividend yield of this selection is still 6% which is relatively high and consistent with all the ERM portfolios I build with my students. I remain a firm believer in dividends and generally do not like portfolios that do not reward me for holding onto them.

#3 There is a “barbell quality” to a resilient portfolio

A barbell portfolio consists of stocks that achieve better growth but has lower yields combine with higher-yielding stocks with lower potential for growth. One class of investments complement the other. The data-centre REITs with Keppel Pacific Oak REIT are the growth counters with EC World, Sasseur REIT and AIMS APAC REIT as yield providers. The major surprise is that given the Chinese origins of the COVID-19 outbreak, the portfolio should not do well, given that two counters have properties in China.

Readers are advised not to copy this portfolio wholesale.

I believe that if the markets recover, it is highly unlikely that this combination of stocks will rebound very well when markets do rally. Instead, investors should think about incorporating the broader principles to tilt their portfolios more defensively. If I improve on this SRS account, I may just combine a stalwart like Keppel Infrastructure Trust with a reckless dividend bet like Eagle Hospitality Trust that many investors have grown to hate in recent months.

In all cases, this is the wrong time to mess with the markets. So, if you decide to engage in bargain hunting, do diversify across many stocks, split your capital and inject your money into the stock markets over the next few months.

Christopher Ng
Christopher Ng
    Juris Doctor(Cum Laude) Bachelor in Engineering from NUS (1st Class Honours) Masters in Applied Finance also from NUS. CAIA, FRM qualifications and passed all three CFA examinations. I have recently completed my Juris Doctor and have been called to the Singapore Bar. For the past 15 years I was an IT manager and I have worked in multinationals, financial exchanges, trade unions and even a government agency. I started my career as an AS/400 administrator and moved on to manage IT projects and operations. Through my personal savings and investments, I earned my financial independence at age 39 after my investment income started to exceed my monthly take home pay. One of my first acts upon retirement is to go back to Law School to reinvent myself as a legal professional. I am likely to be in the practice of corporate litigation. My three books on Personal Finance explain the processes by which I attained my financial independence. Growing your Tree of Prosperity was a local Straits Times bestseller in 2005. I was featured in Me and My Money sections in the Sunday Times twice. I also play the role of a husband and a father.
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