How to navigate a crisis: lessons from a chief investment officer

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Yves Bonzon, Group Chief Investment Officer, Julius Baer: When the weather is beautiful and the sea is quiet, everybody is a good sailor. It's in rough time that you can make a difference.

Robin Pomeroy, host, Radio Davos: Welcome to Radio Davos, the podcast from the World Economic Forum that looks at the biggest challenges and how we might solve them. This week how to navigate a crisis - we hear from an expert in investing who tells is how he has navigated the stormy seas of financial crises, wars and pandemics.

Yves Bonzon: When you look at the market reaction you can see that the market was was really taken by surprise. Suddenly it woke up one morning and said, woah, this time it's for real.

Robin Pomeroy: Radio Davos teams up with Moving Markets: The View Beyond, the podcast of Julius Baer, to talk to the private bank’s chief investment officer. Yves Bonzon tells us how some crisis come out of the blue, but even those you can see on the horizon usually contain some unknown unknowns.

Yves Bonzon: Even a crisis you anticipate and you think it's a matter of when not if, there are surprises along the way.

Robin Pomeroy: And, in a risky world, he has advice on how we should approach risk.

Yves Bonzon: A reasonable degree of volatility is not only normal but actually warranted in a portfolio. Something that is flexible is actually more robust physically than something that is completely rigid, by the way.

Robin Pomeroy: Follow Radio Davos wherever you get podcasts, or visit wef.ch/podcasts where you will also find our sister programmes, Meet the Leader and Agenda Dialogues.

I’m Robin Pomeroy at the World Economic Forum, and with this joint episode of Radio Davos and the Julius Baer podcast The View Beyond, looking at how to navigate risk…

Yves Bonzon: Most important is if you're wrong, not to stay wrong.

Robin Pomeroy: This is Radio Davos.

Bernadette Anderko, host, The View Beyond: Hello everyone, my name is Bernadette Anderko and I'd like to welcome you to this week's edition of Julius Baer's View Beyond podcast. And it's a special edition today for multiple reasons. Firstly, this week I'm being joined by a co-host Robin Pomeroy, who is responsible for the World Economic Forum's audio content and is the host of Radio Davos.

Hello and welcome to you, Robin.

Robin Pomeroy: Hi, Bernadette, great to be here and hello to listeners of View Beyond. It's great to be doing this joint episode with you.

So listeners can hear this on your podcast and also on the World Economic Forum's podcast, Radio Davos, just to tell you what that is and tell your listeners what it is, it's the weekly podcast that looks at the big issues of the world: economics, technology, health care, jobs and skills. The list goes on and on. But we have it with a lens of what are the big challenges facing the world and how can we overcome them. And every week we're talking about a different issue and trying to find better ways of doing things.

Maybe for people who are listening to this on Radio Davos, Bernadette, you can tell us something about your podcast.

Bernadette Anderko: Indeed, yes. So The View Beyond is the weekend edition of our daily Moving Markets show and on that podcast, we're very much focused on what's been happening in financial markets in the previous 24 hours, as well as touching on why.

The View Beyond gives us the opportunity to dive deeper into a specific topic that's been on investors' minds during the week and allows us a little more breathing space to interrogate the subject with our experts.

Robin Pomeroy: Great, well, really happy to be doing this joint programme. And on this joint podcast, we're looking at navigating crises. And to talk about that, Bernadette has found us a great guest.

Bernadette Anderko: Indeed I have. Julius Baer's Group Chief Investment Officer, Yves Bonzon, who knows a lot about the difficult issue of investing throughout crises. Hello Yves and thank you for joining us.

Yves Bonzon: Hello Bernadette, hi Robin, thanks for having me.

Bernadette Anderko: So, Yves, as someone who's been a CIO, I think, for more than 30 years now, and even more experienced managing investment decisions on behalf of private clients, you've had the unenviable task of having to navigate multiple crises. We've had The Asian Crisis in 1997, The Global Financial Crisis in 2008, of course COVID, in 2020 and now unfortunately the US-Iran war.

Perhaps I could start by asking if you've got some sort of rule book as to how you'll react when sudden shocks hit financial markets. I mean are there specific steps that you follow, things that you particularly analyse before you make those first actions?

Yves Bonzon: The first point I'd like to make is that every crisis is different and most investors see crisis as a danger.

Unfortunately, or fortunately, every crisis is different. In terms of the conditions that lead to that crisis, the catalyst and the driver, the forces that work in the system during the crisis, as well as, critically, policymakers' response, adequate in size in nature or not, to the crisis.

Bernadette Anderko: And I know that you often make reference to exogenous and endogenous shocks, because I've read it enough in your weeklies and monthlies, so shocks that come either from outside or within the economic system itself, but does that make a difference then to how you shape your reaction.

Yves Bonzon: It does at two levels.

In theory, first of all, you cannot predict external shock, these are exogenous to the system.

So that creates an opportunity, especially when you manage private client assets, private wealth, our clients typically have very solid balance sheet with some untapped risk-taking capacity.

The problem is some of these exogenous shocks can have endogenous consequences. A good example is COVID in the recent past. Suddenly there is this virus, the pandemic starts. This is not predictable. This hits economies. Of course, the first policymaker's decision is the shutdown to protect the healthcare system from being flooded with severely affected patients. That's a policy decision.

Then there is a second critical policy decision, which is that massive combined fiscal monetary stimulus and the way and how that stimulus is implemented, in particular, the size of the stimulus and the duration of the support, of course, matters. In the case of COVID, probably size was too big, duration was too long. And this led to a stronger inflation impact than expected in the economy.

So an exogenous shock like this can lead to endogenous consequences. And there, it's an important distinction.

Finally, endogenous crisis. And you mentioned 2008, the great financial crisis. This is totally endogenous, you know? We have a much better understanding of endogenous mechanism, the impact on the system, how this will impact the balance sheet in which we invest because as investor, we fund balance sheet and all balance sheets are interconnected with each other, right? So we understand better how a crisis, a sort of a wildfire like 2008, propagates. And we also understand. What type of conditions must be fulfilled for the fire to be contained.

Robin Pomeroy: We're in a crisis right now, and I think some of what you've just been saying can be seen in the way governments or individuals and investors are looking out on the outlook of the Iran war. And we can see it every day or every minute in the oil price going up and down. And a lot of that seems to be people wondering when the thing will end.

So my question to you, Yves, is how do you distinguish between a temporary shock that's going to change things like the oil price in this case and then lots of other things, or something that's now going to be fixed in for the medium term and kind of what difference does that make to the decisions you're making?

Yves Bonzon: The current crisis is an interesting example because you can draw parallels with what happened in 1973-1974 with the oil shock at that time.

So you have this exogenous shock, the start of the war in Iran, and this time around the first observation we made is the reaction of capital markets, the rise in equity risk premia and volatility is rather mild, muted, contained. So even if it's a temporary shock, we didn't assess the shock at the time as a great opportunity to add risk, you know, in a favourable timing, simply because the reaction was not really very significant.

At the second stage later, during the month of March, the conflict started to target infrastructure, energy infrastructure, and there our degree of concern increased slightly. Because closing the Strait of Hormuz is a decision you can reverse reasonably quickly. Damaged infrastructure takes time to repair.

But of course, the circumstances, such as the petrol intensity in GDP today compared to the 1970s, the circumstances are also different. And pretty quickly, markets have been discounting a robust energy infrastructure and system globally.

Many countries produce oil. By the way, the starting point was very, very ample inventories of oil and refined products and a market in structural oversupply. So that's a favourable starting point.

And very quickly the market started to discount a rebalancing of energy. Admittedly an oil shock of some $30, $40, that can be absorbed and that's where the conditions in the system, and I refer again to balance sheet, one of the absolutely critical thing to have in mind today is that in the West, primarily US, Europe, but as well Japan, in developed economies, private sector balance sheet. And this applies equally to corporate balance sheet and household individuals, private individuals balance sheet are strong because since the post financial crisis time, the private sector in the developed world has deleveraged.

So this shock nowadays hit the system which is deleveraged. And the impact therefore is much less severe because the system is much more resilient to those shocks.

Long story short, you have to take all of those elements into the equation to assess whether it's an opportunity to increase risk and take advantage of the risk aversion spike or if you should hedge and very critically you manage that by gradually adding or reducing risk in such a situation with the ability to quickly reverse a decision.

Most important is not to predict what happens next month. Most important, is if you're wrong, not to stay wrong.

Bernadette Anderko: I mentioned other crises that you've had to navigate in your career, Yves. Is there one that stands out as being particularly memorable and if yes, perhaps you'd explain why?

Yves Bonzon: By far, the most interesting, from a personal and career perspective, was 2008. Because 2008 being endogenous in nature. Here is a crisis that if you have the knowledge, if you have the right counterparties to support and help you understanding the mechanism and forces at work in the system, you can really take advantage.

By taking advantage I mean you can mitigate the drawdown of your portfolios during the phase where the crisis is intensifying. And when we are reaching the climax and we are on the tipping point of the crisis, obviously it was late March, early April 2009, you can normalise very quickly your risk load which leads to very good performance and a swift recovery of portfolio values.

So you've actually enhanced returns by taking advantage of the crisis. And of course this involves being temporarily in a low double-digit drawdown in most portfolios.

But again, you construct future performance by taking advantage of overly stressed valuation during such market episodes. And by any measure, as far as I'm concerned, in those crises I've experienced, first one was the crash of '87. 2008 is really a crisis I really enjoyed a lot steering the ship as a CIO.

The tariffs thing was much more difficult. Because you're dealing with a volatile administration, it's not clear what they are up to. It's exogenous in nature, back to the nuance between exogenous and endogenous. Much more difficult to navigate.

Robin Pomeroy: I'm interested in this idea of an "enjoyable crisis" from your point of view and one that's less so. It seems to be that if it's more predictable, once the shock has happened, like in 2008, then you can use your powers of analysis and your team of analysts to work out where the best course of action lies. But if you're facing lots of uncertainty, as with Washington's tariff regime, which has changed so often, that's difficult because you're not relying on kind of hard facts. Is that basically what you're saying?

Yves Bonzon: The first observation I'd like to make, and drawing a parallel between CIOs and statesmen with all the usual reserves, you know, there is no such thing as great political leaders without a crisis. And everybody would have long forgotten Winston Churchill if it was only for his role in the First World War. It's really the Second World War that made him one of the all-time great and famous political leaders of modern times.

So the crisis is an opportunity. For somebody who loves what he does and he's good at it to make a difference. When the weather is beautiful and the sea is quiet, everybody is a good sailor, right? It's in rough time that you can make a difference. Hence my qualification of enjoying the crisis, Yes, because that's when you can make a difference, right?

Robin Pomeroy: Right, it reminds me of, you know, I'm a news reporter at heart.

Yves Bonzon: You like crises too, do you?

Robin Pomeroy: I'm ambivalent, but I understand exactly what you're saying.

Yves Bonzon: Above and beyond that, Robin, is the issue of how our human brain works. You know, and that's the teaching of Nobel Prize, Daniel Kahneman, our brain was built, you know, trained and programmed for survival in the wild times of the Stone Age. And we have developed two brains, the emotional brains and the rational brain, and of course emotions take over during crisis, and it's really an opportunity if you can stay rational to make a difference.

Robin Pomeroy: I'm going to hand back to Bernadette in a moment. There's one more I was going to ask you.

You've already mentioned you've got a crisis on your hands. There are kind of two things. It's a threat. So it's a threat to the capital you're managing, but it's also can be an opportunity. There will be places where if you if you invest in certain areas, you're going to get better returns because maybe other people aren't investing in those areas, for example, or you've seen an opportunity that others haven't seen.

Do those things go hand in hand for you or do you first think right we've got to make sure this capital is safe and then a few days later we're thinking okay let's look at the the opportunities I mean how do you kind of weigh the two things?

Yves Bonzon: So, one needs to understand what his or her mandate is.

So, if you're a hedge fund manager and you have a formula for compensation purpose, earning a cut on your profit and loss statement by year end, your time horizon is 12 months. Obviously, you're a trader, you have really an absolute return mindset, an absolute return investment objective.

We are wealth manager. Our mission is to make sure our clients stay rich. They got rich primarily in two fields, real estate or more often entrepreneurship, building companies. These are the two main sources of wealth creation in the economy and our value proposition or duty to them is to help them stay rich in relative terms.

I always tell clients In life and markets, everything is relative. Everything is relative, and especially, for instance, if you help ultra-network individuals manage their money, I always tell them, look, your benchmark is MSCI World. Your peers are large shareholders in the companies that populate those famous and leading world equity indices, and that's your cost of capital. Meaning if you lag MSCI world by a significant margin on a relative basis you're getting poorer relative to your peers and by the time you want to buy that very nice property in Tuscany there will be other bidders with more firepower than you.

The point I'm getting at it's really a question philosophically and that raises the topic of drawdown and all the investment biases, behavioural biases associated with him, one of which is the typical anchoring. Here comes a liquidity event, somebody crystallises a large amount of money in that transaction, an initial public offering or a corporate M&A transaction and suddenly the number that has been crystallised become a sort of obsession.

This is extremely counterproductive. Of course, you want to mitigate drawdown because every time markets recover and you start to compound returns again, you want compound. Of the highest possible base for the future. But a reasonable degree of volatility is not only normal but actually warranted in a portfolio. Something that is flexible is actually more robust physically than something that is completely rigid, by the way.

Robin Pomeroy: When is a crisis a crisis? Sometimes things come totally out of the blue, but I guess that's fairly rare. Normally, there's some kind of buildup. Even in COVID, we were getting reports of a virus happening somewhere in a town in China, and it took a few weeks perhaps for the penny to drop with investors, or did it? Another example would be in a war situation you see a build-up of military equipment on the border with a country like Ukraine, and Russia's saying, oh, they're not going to invade, but then suddenly they do, and that becomes a crisis.

I wonder, when do you decide, oh, this issue's a crisis, and it's really going to change the way we are acting in various ways?

Yves Bonzon: So again, very different approach depending on whether the buildup into the crisis is of endogenous or exogenous nature.

You mentioned COVID as an example. There have been so many other virus cases that have gone essentially nowhere that it's extremely difficult to say, Oh, this time the virus is serious enough. We need to pay attention you know.

And when you look at the market reaction you can see that the market was was really taken by surprise you know suddenly it woke up one morning and said well this time it's for real - it's the remake of the Spanish Flu movie.

Robin Pomeroy: Do you remember in that case, what was that moment? Why suddenly did the market...

Yves Bonzon: I remember it was some time in February 2020 and you can tell because it's the first roll on leg in leading equity indices when the market woke up to that and realised it's very serious.

Of course, the way in how the market responds and the depth of the drawdown was at the I'm directly a function of the decision very quickly thereafter by governments to go into shutdown mode, and that was not expected either.

By the way, during the Spanish Flu, nobody went in shutdown mode, you know. It was a different time and with different communication means, I guess. And a much lesser ability. Without the digital economy, and if the internet had not yet been invented, I think the appetite for shut down would have been far more limited among governments.

Back to a good example of endogenous crisis, the financial crisis 2008, the banking crisis. This one we saw coming three, four years in advance. And. You know, the system continued to build. One of the reasons we saw it coming is because we were invested with a few managers who had a very good understanding of the pitfalls and flaws in the securitization of subprime mortgages. But even in this very, very historic example, even though we understood the flaws in securitization of subprime we did not expect to find them on banks' balance sheet.

Let me explain. So we knew these assets were not AAA rated bonds, you know, or bonds equivalent. And we knew some naive money was buying them in believe they were triple A that they were not. But we thought that those who manufacture those instruments, the investment banks, knew that these were not real triple A, that these where faked triple A's, right? Actually they did know except the department managing the treasury of those banks is in a different area of the city from the department manufacturing and they were not talking to each other. So as some colleagues were busy manufacturing those pseudo AAA papers, treasury operations were happily holding them on the balance sheet.

And the big surprise was not the start of the great crisis with early innings beginning of '07 that was the revelation second half of '07 that some of the most important, most systemic banks in the world had piled up those highest rated tranches of subprime papers on their balance sheet, right?

So you see even a crisis you anticipate and you think it's a matter of when not if, there are surprises along the way. It does not necessarily play out as per a pre-designed script. And of course, the fact that the financial infrastructure was impaired made the crisis much worse than it would have been otherwise. You know, otherwise it would have been a shock on the housing, a negative wealth impact on American household balance sheet, which of course is negative for consumption. And let's say we would have had an average recession. The fact that the financial system was impaired led to a deep recession.

Robin Pomeroy: That's one of the highlights of your career of dealing with crises, Yves. You also mentioned your career stretches back to the late '80s. The world has changed a lot over that time. You mentioned the COVID situation. Countries wouldn't have been able to lock down if we weren't all able to do at least some of our business and our communications online. Things have sped up when it comes to trading and communications. We're now in the era of AI. I just wonder if you noticed over the years, since the 80s and through to today, how crises developed differently and how your approach to crises would you say is different today than it would have been in 1990?

Yves Bonzon: I don't think my approach would have been different.

I think on a personal level, there is a rare group among investment professionals that has inherited a very strong intuitive intelligence ability.

You know, I would refer for those interested in topic to watch, listen and reflect on one of the old time great interviews, Stanley Druckenmiller. The former CIO of Quantum Fund, George Soros Fund. Stanley explains this extremely well in his interviews. He has that ability and you have it or you don't have it. There is a debate. Can you groom it or do you have? That's not the topic of this podcast. Let's not get into this. I would tend to believe Stanley is right. You have it, or you do not have it.

The problem is, as we said, every crisis is a bit different. And you know, you reach a point in your career where experience is a blessing and a curse. Because you think you've seen the movie before, but it's actually different.

Let me give you a concrete example. To a much lesser extent today, but still two, three years ago, there was a pretty widespread consensus in the market that the so-called FANG stocks, the Magnificent Seven, were simply a remake of a movie that people had seen before in 1999, 2000 with the dot-com boom bust cycle and the telecom capex cycle. And of course, if you were a kid at the time and you started your investing career or investing your own money in the decade 2010, post-financial crisis, post-NASDAQ bear market, you're not stigmatised by what happened at the time and you're at risk of extrapolating.

So, very important is to keep that intuitive intelligence skill, but making sure that you are not actually overly biased and influenced by your personal professional life or investor's life experience falling into the trap of believing you are in the defined patterns you've already seen but actually are different.

Bernadette Anderko: So you talk about traps there. I wanted to ask you a last question. In your opinion, whether there are certain traps that people sometimes fall into when making investment decisions, especially during the crisis and things that you would highlight perhaps to be wary of. I mean, when we look at behavioural finance and I know I'm guilty of this myself, sometimes we make emotional decisions when we're making investment decision.

Yves Bonzon: Absolutely. Those decisions can prove immensely expensive. And by the way, they're not specific to crisis. They happen every day.

When is the best time to invest? This morning. And the next day? Next morning.

The point I'm getting at is individuals have a tendency, not all of them, but most of them to be overly risk adverse to draw downs, to have a poor understanding of the statistical distribution they are confronting in the game of investing they are playing. And as a result, leave a lot of money on the table.

Robin Pomeroy: Probably a lot of people listening to Radio Davos won't be in your field of work and probably a lot of them won't be high net worth individuals but I wonder what wisdom they might draw from what you've been saying.

I think it's been very interesting what you're saying about emotional or or non-emotional analysis. Do you think someone who looks at risk every day and makes tough decisions, the kind of high stakes decisions, has any lessons they could apply to their daily life, to their own daily life? Or that other people would think, you know what, I'm clouding my judgement by this thing. If I could just think more clearly about something. Do you think there are lessons all of us could learn from you?

Yves Bonzon: I think the good news is even for a smaller number of investors, there is plenty quality publication tutorials helping them understand the dos and the don'ts of investing.

So the point I'm getting at is very important is to educate yourself and that is equally important. If you delegate or don't delegate the management of your assets to a professional investor. Because if you do it by yourself, of course, you have to have a good understanding of all the things you should not do. And the list is longer than the things you should do. If you delegate to a professional manager, of, course, you have the ability to assess whether he is the right choice and he's going to do a good job and add value over the years for you.

I have good news that the access to that knowledge is available especially in today's digital times but it requires a personal effort to take the time to understand, invest the time.

And then of course you know everybody knows smoking is not good for your health but some people smoke you know most people would admit that selling in an emotional market drawdown tends to be more often wrong than right and by the way there are always two decisions people forget. They sell you know under the pressure of emotion but they forget there's a second decision is when do you come back. So you need to get both right. Just run the mathematics of how much you can add to your portfolio return by timing the markets with perfect insight, a perfect crystal ball, and your appetite for wild market timing decision might be accordingly be severely recalibrated to more modest levels.

But the point I'm getting at, you need to understand investing. In the same way, you would not build the car and drive it if you're not an automotive engineer, right? It would be too dangerous, but that's the same thing.

And frankly, you can do simple things that are not rocket science, but following the doctor's prescription, following the recipe requires discipline, you know, and you need as an investor or as the client of a professional investor, you need to discipline yourself. This will lead to much better results over time.

Bernadette Anderko: Talking of discipline, I'm afraid we are now out of time, Yves. It's been fascinating to get your insights today and a real pleasure to hear what you're thinking firsthand. And thank you also Robin so much for joining us today.

Yves Bonzon: Thank you Robin, thank you Bernadette, it was a pleasure.