However certain our expectation, the moment foreseen may be unexpected when it arrives. — T.S. Eliot

Everyone is expecting a big negative credit event. Leverage is high. Overall debt is high. Growth is still low. Loose monetary policy continues at extremes through quantitative easing that has supported the extension of the global credit cycle. Nevertheless, the knowledge of a large downside tail event does not mean that investors are prepared with an action plan for when the downturn arrives. Investors can still be unprepared for what they will do with their portfolio when the time comes.

We suggest investor play a “war game” to walk through the steps that should be taken under downside scenarios. The game can be played through a few simple steps.

Step 1: Isolate an event – Assume a specific downside event. For example, what happens if there is an escalation of a trade war with China?

Step 2: Walk through the implications of the event. What markets will be affected? What will happen to the correlations across these markets? Are the market effects expected consistent with cross-market relationships? What will be the reaction of other investors?

Step 3: Portfolio review – Can the current portfolio take advantage or mitigate the risk event? What are the risks from this event?

Step 4: Analyze the restructuring alternatives that will be effective for hedging against this downside event. Be specific on what you will buy and sell? 

Step 5: Analyze whether your hedging will meet your return expectations.

Step 6: Walk through other possible solutions.


The process of preparing for portfolio alternatives will allow for an effect plan to minimize risks when they actually come to pass.