March is the time of year when almost everyone becomes a basketball fan — cheering on teams, participating in office bracket challenges, and feverishly following basketball underdog stories. So, the ‘madness’ also makes for a great opportunity to help explain some investing do’s and don’ts.
Opening Tip: Emotions Won’t Help You Win
I’ve written about the parallels between March Madness and investing before, but given how volatile the financial markets have been this past year, there’s more to expand upon. Emotional investing – based on fear, greed or some other reason – can cost an investor dearly. Starting in March 2020 when there was a huge sell-off in the market and volatility was at all-time highs, there were a lot of knee-jerk reactions and emotional investing. But emotional investing only negatively impacts a long-term investing strategy. People who stayed the course with their long-term strategy were rewarded with gains this past year.
When strategizing for your team or portfolio, picking blue blood teams to win your bracket or blue-chip stocks for your portfolio, are typically safe bets. But as we all know from this pandemic-stricken year, who and what truly defines safe is not guaranteed, and sometimes changing strategy is necessary.
Duke and Kentucky, two of the most well-known blue blood basketball teams, did not make the tournament this year. And another well-known blue blood, UNC, is seeded lower than we’re used to seeing. In the markets, the big tech names like Apple, Amazon, Google and Microsoft, may not be where you want to allocate all your money right now either. We’re seeing a rotation out of technology, and this year may be the year you need to find other investments to help carry your portfolio, like high quality companies found in more cyclical sectors like financials, industrials, materials, and even energy. Just like you’ll have to find other teams to carry your bracket, such as more blue-collar teams like the Gonzaga Bulldogs, Villanova Wildcats, or even the Baylor Bears. While many topics from my previous March Madness blog still hold true, some things have changed, like a rotation out of tech, fallen angels and Special Purpose Acquisition Companies (SPAC). So, here’s how this year’s hot investing topics correlate to the madness of the single-elimination college basketball tournament.
Boom or Bust
In the past ten years, bracket participants are getting bolder. Every year more and more people are picking 16 seeds to upset 1 seeds in their brackets, which has only happened once in the history of the tournament. So picking 16 seeds to upset 1 seeds can very easily bust your bracket, just like buying a bankrupt and/or junk rated stock can very easily bust your investment portfolio. We saw this pandemonium play out recently with retail trading activity surrounding Hertz last year, and the ‘Reddit Revolution’ and frenzy around stocks like GameStop and AMC; some made a lot of money, others lost a lot. Building an investment philosophy around buying bankrupt stocks is not a sound principle, just like picking 16 seeds to upset one seeds to build your tournament bracket.
Instead of hoping for the slam dunk, picking the 12 and 11 seed upsets in your bracket is more calculated and similar to investing in a company that may not be profitable quite yet, but perhaps will be in the future. An example of calculated risks would be tactically overweighting asset classes in your portfolio relative to their long-term targets, to capitalize on the current and future expected market environment, such as overweighting small cap stocks, overweighting international equities (primarily emerging market equities). Historically, during the early phases of recovery, expansion, and reflationary periods, certain areas and asset classes tend to perform better as they capitalize on improving global growth and expansion. Because these asset classes typically carry higher levels of volatility or risk, making minor tactical changes to your long-term targets could be seen as calculated, despite exposing more of your portfolio to riskier asset classes over the short term. Other examples of calculated risks in the investment world might include renewable energy and Electric Vehicle (EV) companies. Just because they aren’t profitable right now, doesn’t mean they aren’t a good long-term investment. You have to be willing to accept the short-term volatility, as there are themes taking shape right now that will play out longer-term. The key, just like picking the right 12 and 11 seed upsets, is to spend time getting to know those companies and how they may benefit from trends just now starting to form.
SPAC Attack and Fallen Angels
Everyone loves a Cinderella team during the tournament because they have a great story that gets a lot of media attention and support from the masses. Special Purpose Acquisition Companies (SPACs) are an investment hot topic in financial media these days. With more than $80 billion being invested in U.S. SPACs in 2020, investors like Shaquille O’Neal, Steph Curry, Serena Williams and a number of others are buying in. But there’s still caution to be had because SPACs don’t have the same regulatory process as other companies going public through IPOs. With the level of risks accompanying SPACS, you don’t want to put all your money in one basket. If you’re going to invest in them, proceed with caution and look to make SPACs a very small portion of your portfolio, just like you would make a potential Cinderella team, a small portion of your bracket.
Building a team or portfolio strictly based upon rankings, has the potential for diminishing your long-term success, as we’ve witnessed this past year with bonds. If you build out your bracket just by looking at the NET and KenPom rankings of teams, your long-term success is going to be diminished. The same goes for picking bonds for your portfolio. The market witnessed a lot of ‘investment grade’ BBB-rated bonds downgraded to junk bond status as their credit ratings took a hit during the heart of the pandemic shutdown, making them ‘fallen angels’. Focusing solely a bond’s rating could lead you to adding bonds of companies on the brink of credit downgrades, which could cause you to experience large losses on what are perceived safer investments – ‘investment grade’ bonds. Conversely, fallen angels present attractive buying opportunities for high yield, or junk bond, managers; allowing them to add higher quality junk bonds to their portfolios, often at a discount. Given the amount of credit downgrades we witnessed in 2020, it’s no wonder about 50% of the junk bond market is now rated BB.
Ratings can often be misleading and adding, or even excluding, securities solely based on their ratings could lead to portfolio losses or missed opportunities. The same way picking your bracket based solely on the lowest rankings (NET or KenPom – lower is associated with being better) or seeding could leave your bracket susceptible to the ‘fallen angels’ of the tournament, those that were ranked highly, only to be upset in the first round, or even the round of 32. Conversely, identifying the pre-tournament ‘fallen angels’, or those that may have suffered a couple of losses leading up to the tournament, causing in their rankings to fall, could prove to be high-quality tournament teams that could result in some upset victories. In investing and basketball, it’s best to look beyond just ratings and rankings and think about the sum of all of the parts. Balance is key.
Throughout the tournament’s history, there has only been one Final Four where all top four seeds made it to the final, so why construct your bracket just with top seeds? A better predictor is the sum of your teams’ rankings. Typically, the sum of the Final Four teams tends to be between 8-11, so you’ll need some lower seeded teams for your bracket’s Final Four. Put this into the context of the bonds in your portfolio. If you’re aiming for an A average, you’ll want a mix of AAA and AA bonds (which can be viewed as the one and two seeds), BBB bonds (like a 4 or 5 seed), and some junk bonds (the 7 seeds or lower). By sprinkling in some bonds that have lower ratings, you give yourself the opportunity for higher yield while also maintaining some safety. Again, the key is balance.
It’s important to remember that investing should be done for the long-term. And while it’s fun to compare investing to basketball, March Madness only lasts a few weeks. You want your money to last for decades. Making smart, prudent choices for a long-term investing strategy is always the best bet. Remember, that if you’re going to include risk, you need to make sure it’s calculated and that the juice is worth the squeeze. Consider working with a trusted advisor who can help you take the emotion out of investing. Here are some tips for picking the right advisor for you.
Disclosures: The preceding commentaries are (1) the opinions of Chris Osmond and not necessarily the opinions of PCIA, (2) are for informational purposes only, and (3) should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. Past performance is no guarantee of future results. Advisory services offered through Prime Capital Investment Advisors, LLC (“PCIA”), a federally registered investment adviser. PCIA: 6201 College Blvd., 7th Floor, Overland Park, KS 66211. PCIA doing business as Prime Capital Wealth Management (“PCWM”) and Qualified Plan Advisors (“QPA”)