Significant market corrections and the ripple effect on your portfolio

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Safeguard against low probability-high impact events Rising interest rates in a developed market to tackle inflation is one such example and one of the biggest threats to asset prices. In a rapidly rising interest rate environment, even a cautiously leveraged company may find itself heavily leveraged. Individual borrowers may find themselves financially squeezed due to higher equated monthly instalments and prolonged tenure.

Thus, it causes demand destruction and ultimately impacts asset prices adversely. Whilst predicting any event, it’s akin to trying to forecast the outcome of a ‘coin toss’—deciding, based on that, who will win the match. The logical approach is to split this problem into two parts: being probabilistic and not deterministic about the event’s occurrence.

As for the impact part, investing can be assessed by considering the current valuation and evaluating how much deterioration the event may bring to the future cash flow of the company. What should one do? We cannot predict the event nor control the outcome. However, as investors, what we can control is our own asset allocation.

Strategic and tactical asset allocation could help. For example, a strategic decision for someone could be a 50% equity and 50% fixed income at the portfolio level. Nobody could predict covid.