What Formula 1 can teach us about investing

Formula 1 and investing

Managing risk in F1 is paramount, sharing many similarities to investing. Essentially, managing risk requires data to make informed decisions.

An F1 car has more than 100 sensors which monitor some 10,000 components, giving feedback on all sorts of data such as tire pressure, fuel burn and brake temperature, etc.

Data feeds into the team’s data centre, which in real-time, together with the driver, assess how to make the optimal risk-informed decisions.

Taking emotions out of investing

That’s how investment should be done. Without data, investing based on emotion - greed or fear - is the main cause of why so many people are buying at market tops and selling at market bottoms.

During times of market euphoria, some investors due to the fear of missing out (FOMO), rush into a toppish market, underestimating the risks associated with investments, making suboptimal decisions based on emotions.

Similarly, during times of market sell-down, due to fear and risk aversion, some investors may be unwilling to take on calculated risks.

Therefore, one of the ways to remove emotions out of investing is to adhere to principles like portfolio diversification and regular rebalancing.

Ideally, the investment process should be done by a team of investment professionals, taking the emotions out of investing, just like a world-class F1 team, with set investment objectives and risk limits.

Racing ahead: Modernizing investing

The word “risk” derives from early Italian “risicare”, which means “to dare”. Investing is not just about daring to take risk, but to manage risk.

Managing risk is about seeing the world in range of potential outcomes - the good and the bad - and attaching probabilities to them. It is using data to help investors with the probabilities and possible actions.

Risk management is maximising the areas where we have control over, while minimising the areas where we know little about.

On an asset allocation construction, data can be used to optimise the asset class mix by considering correlations between asset classes and how much risk the portfolio is allowed to have.

At a single stock level, there is a need to use data analytics to better understand the risk exposure such assets will bring to any portfolios. Be it from the perspective of risk exposure changes over time or concentration risk across sectors, issuers and geographies.

Stress testing is another useful tool to assess the resilience of portfolios against hypothetical or historical “black swans” events.

By using historical shock such as the Global Financial Crisis to stress test their portfolios, investors can identify the risks and vulnerabilities arising from their current exposure. By doing so, investors can have a better appreciation of the underlying fragilities embedded in their investments, allowing them to make immediate and precise adjustments.

Just like in F1, the use of data will give investors an advantage, and make more informed investment decisions.

F1 and investing is about adapting

F1 racing is about monitoring the data from the racing track, weather, wind speed, etc. However, if it starts raining, especially in tropical Singapore, the F1 team needs to quickly adapt to the new condition where the track may not give enough friction and making fast turns can be treacherous. Similarly, in investing, there is a need to adapt when economic conditions change.

In both F1 and investing, being prepared is better than predicting the future. Market turbulence is inevitable, and preparedness is key.

With a diversified portfolio as an anchor, there are a few strategies which investors can adapt to the current environment of high inflation and volatile interest rates:

#1 Raise portfolio resilience: With high and sticky inflation, a pure equity-bond portfolio is insufficient. Diversification is more important than ever. There is a need to get diversification from alternative assets such as private equity/credit, hedge funds, private real estate and commodities.

#2: Manage bond duration: there is a need to manage bond duration by rebalancing away from long duration into shorter duration bonds. Focus on shorter duration investment grade bonds.

#3: Look for floating-rate income: For investors with excessive cash and low-yielding fixed income exposure, there is a need to shift into asset with cash flows that can reset higher in the event of high inflation. Infrastructure, senior loans, and real estate are good candidates for such income assets.

#4: Quality companies with pricing power: focus on quality companies with strong pricing power - companies with the ability to preserve profit margins despite of rising cost pressures. Look to quality companies with solid dividends.

Beyond the adrenaline rush, the F1 offers many lessons for investors to better position their portfolios to score.

A contribution piece by James Cheo, Chief Investment Officer, Southeast Asia, HSBC Global Private Banking & Wealth. A version of this piece was first published in The Straits Times on 3rd October 2022.