Downside Protection Isn’t Measured in Days

The only thing more striking than the depth of the recent market rout is its speed. It took the S&P 500 just 22 days to fall 30%, the quickest drop of that magnitude in history. The fast freefall has left little time for equity strategies touting downside protection to deliver it … but give it a moment. Stock selection can help navigate equity market downturns, but it provides greater value over a longer period than three panic-stricken weeks.

At Dana, we pride ourselves on the ability to outperform in sustained bear markets and our strategies did so through both the tech bubble and great financial crisis. This is largely what we would expect, given our investment process. We focus on high-quality companies that trade at a discount to their peers. These companies tend to outperform when the economic outlook sours and the rest of the market gravitates toward companies with stable balance sheets and steady earnings growth.

We see early signs the market is once again starting to differentiate between high and low-quality companies. But a bias toward smaller companies and a tilt toward value hasn’t yet helped us in the current downturn.

As stocks slid from record highs to bear market territory in a matter of days, not months, the thing that would really make a strategy shine in the current market environment is to increase one’s allocation to cash. We view this as a market timing call, however, and it’s simply not what we do.

Is Your Manager a Timer or an Investor?

In the earliest stages of a bear market – particularly this one – the best way to cushion the fall is to hide in cash or short equities. Undoubtedly, there have been some long-only managers that have probably benefited from holding excessive cash positions during the recent rout.

However, if you’re an advisor or investment consultant – is that what you hired a long-only equity manager to do? And if you didn’t pay them to time the market, are you confident they will get it right and be fully invested before markets trend back up?

At Dana, we seek to make stock selection the key determinant of relative performance. Our funds are sector neutral relative to their benchmarks and we are always fully invested.

We do expect to outperform in bear markets but expect that process to play out over months, not days. As the market moves from “the sky is falling … sell everything” to “the economic environment is tough, who can still thrive?” we expect our holdings to be recognized for the durability of their earnings. While we are starting to see signs that quality matters, it will matter more when knee-jerk panic selling has abated and the market isn’t in freefall.

We haven’t had a prolonged bear market – or even a prolonged period of negative returns – since the financial crisis. Since that time, the S&P 500 has only had eight quarters in which returns were negative, and not once has the index experienced back-to-back quarters of negative returns.

If the economic fallout from the coronavirus does lead to a longer bear market, we like how our funds are positioned for it. We believe a portfolio of higher-quality companies should outperform while the economic outlook is less sanguine. We’ve seen that play out in previous sustained bear markets. And when stocks do eventually rebound, we won’t miss part of it by hiding in cash.


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