Weathering the storm
4 Aug 08
One thing they agree on is that it depends on the investor's risk attitude, but a range of big players in the investment advice field offer diverse advice on the best ways to manage a portfolio in the face of the financial squalls or, as one of our panel notes, what the Chinese proverb would call 'interesting times'
THE BEST OF TIMES, THE WORST OF TIMES
These are not ordinary days for investors, says Justin Urquhart Stewart.
There have always been booms and busts which come along like dangerous squalls and are frightening in their speed and ferocity: but what we are in now is the closest we have seen to a perfect storm in the financial world, covering far more than just a few frothy equity markets. This is affecting monetary issues on a far broader scale. So how should we react to this storm?
Being in a storm takes nerve and determination, especially when headlines of hyperbole are designed to disturb even the most confident of investors. Firstly though, let’s set some ground rules. Investing requires a three-year minimum view and any less, in my book, is short-term betting. There are some well tried investment rules which have stood me in good stead over the years. The first is ensuring that you have a good spread of investments across a broad range of asset classes – not just shares. The greater the number of asset classes, the greater the chance of managing the volatility of the portfolio and from that the predictability of returns.
Those already well diversified before recent events would have seen far less erratic and fearful moves in valuations.
That is not helpful for those who have taken the riskier path of equity dependency. For these people, many of their shareholdings may be sitting at some considerable loss to their
previous value, in which case the message is to hold hard. To sell at what might well be close to the bottom of the cycle would be to repeat the fatal error of many private investors. There is no need to crystallise your losses through fear.
The global sell-off has exposed some stark differences. Not least of these are currency movements which can provide some real medium-term value as sterling quite likely continues its depreciation against a whole range of currencies.
Secondly, some of the longer-term emerging market stocks have returned to more sensible prices; and thirdly, the area that has suffered most (through mainly their own actions) has been the financial services sector. As the banks’ Augean Stables are cleared out, it will leave some damaged but still valuable assets to be invested in.
Remember in a storm, don’t panic, hold your course and let the storm pass.
Justin Urquhart Stewart is a director with Seven Investment Management.
UNDERSTANDING MARKET TIMING
Market timing is notoriously tricky to get right and horribly easy to get wrong, warns Darrel Poletyllo.
Accordingly, it, pays to be cautious with timing, whether looking for the top or the bottom of any cycle.
My firm, Grant Thornton has long understood the vagaries of market timing and seeks to protect clients’ wealth through phasing and the use of highly sophisticated asset allocation.
By phasing, we mean moving in, and out of the market at predetermined intervals, whether quarters or months. In this way we hedge the risk of getting in or out too soon. We have the discipline to take profits when they are there but never in a hurried or excessive way. More often than not, our clients want us to protect their wealth and we focus on risk adjusted returns.
There is a huge amount of science, analysis and research behind what we do, relying on hard fact rather than instinct or conjecture. Based on these principles, we have loyal clients who understand the importance of a longer-term outlook.
We have reacted to increased demand and invested heavily in the development of our cash management service. We leverage our clients’ collective buying power to secure wholesale interest rates whether the client is an individual, business or trust. This service has grown exponentially over the past year as financial volatility has frightened people away from other assets.
Those assets that are viewed as more specialist, such as hedge funds or structured products, can and do have a role to play. They are not core holdings for our clients, though, as the complexity and costs present significant barriers. It is important for us
that investments are transparent and many of these vehicles are not.
Where are we going from here? We would love to know but no one does, despite claims otherwise. Based on historical values, the UK stock market looks like reasonable value but there is still bad news around. Commercial property has taken a real blow over the past few months but does this present a buying opportunity? Not quite yet.
When markets are volatile, everyone runs for the hills and the simple rules of supply and demand have a depreciating effect. The bottom line is that there is no real safe haven or magic bullet. In our view, a balanced approach along with a balanced portfolio is the only way to sleep soundly when all others are losing their heads.
Darrel Poletyllo is a director, specialising in financial planning, with Grant Thornton UK.
INTERESTING TIMES AS CHINA TAKES LEAD ECONOMIC ROLE
“May you live in interesting times” is said to be an ancient Chinese curse and the recent performance of financial markets has certainly been interesting, ironically in part because of the accelerating Chinese economy, Alex Montgomery writes.
Humans routinely swing from over-confidence to excessive pessimism, so economies have always been, and will always be, cyclical. The credit boom was all about confidence which began to ebb last summer as evidence grew that over-enthusiastic lending would come back to haunt the management of many banks.
At the same time, evidence is growing of rising inflation, weakening US and UK house prices and a much more fundamental change: the leadership of the global economy moving eastwards.
Examples of the impact of these major themes can be seen in the divergence of some key sectors of the FTSE All-Share Index. In the year to the end of June 2008, the worst performing sectors have been those exposed to UK consumers, with financials down 32 per cent and consumer services down 31 per cent.
At the other end of the spectrum, companies benefiting from the appreciation in global commodity prices have prospered, with basic materials rising 31 per cent and oil and gas up eight per cent over the same period.
Should investors be clinging to cash and index-linked Government bonds, or is this the moment to be brave and pick up undervalued assets? Timing, diversification and a willingness to move against the herd are, as always, key tools for investors.
No-one will ring a bell to mark the bottom of this down-swing in markets and it is not realistic for anyone to expect to catch it precisely. Investment portfolios should contain interests in a range of asset classes, be tuned to suit the time horizons and risk tolerance of the investor, and be positioned to avoid ever having to sell equity or other volatile assets in times of weakness. Our approach is to blend interests in long equity vehicles (both region- specific and global in perspective) with exposure to fixed interest, commercial property, private equity, hedge funds, structured vehicles and other “alternatives” such as infrastructure funds.
Exposure to some asset classes, such as property and private equity, is now available at wide discounts to asset value. The alert and opportunistic will find areas with attractive pricing that represent long-term value for patient investors.
Alex Montgomery is a partner and head of asset management with solicitors and asset managers Turcan Connell.
DON’T PANIC – THAT’S WHAT EVERYONE ELSE DOES
The unreliability of the direction of the market means financial planners will normally claim that any investment should be based around asset allocation, and a well diversified portfolio, argues Bill Saunders.
It is well recognised that true diversification is the only “free lunch” available to investors, meaning this is the only reliable way to increase returns without a corresponding increase in risk.
Having taken the decision to diversify, it is then a question of ensuring that assets held within a portfolio are as much as possible, in investor speak, “non-correlating”. This simply means taking advantage of asset classes that do not all tend to move in the same direction at the same moment. Over time, this will have a smoothing effect, and hence reduce the volatility of a portfolio.
The term “attitude to investment risk” may be familiar to some investors, but essentially you have to determine how much of your capital you are prepared to commit to equity markets, and how much you want as a safety net invested in lower- risk assets. Having decided on an investment course, it is vital to stick to the plan.
Unfortunately there is plenty of evidence that people do not do this, which is a sure-fire way to wealth destruction.
A study over six years by the Investment Management Association showed that there is a strong correlation between direction of the FTSE All-Share Index and the amount people invest in the stock market. In other words, as the index rises, so does the amount invested.
What the research shows us is prolonged evidence of buying at the top and selling cheap – truly a path to wealth destruction.
So, the message is that investing is generally for the long term and that it really is not in anyone’s best interest to be forced into a knee jerk reaction. There is so much financial “noise” coming at us from all directions these days, but very little of it will affect the longer-term investor.
Bill Saunders is head of financial planning with the Acumen Group.
CORE ASSETS ARE WORTH STICKING TO
Such a huge amount has been written about the “credit crunch” over the past year that it seems that we may have all become experts on rights issues, collateralised debt obligations, sub-prime mortgages and the de-coupling of world economies, writes Ewan Pitcairn.
We all know that banks are struggling, the world economy is slowing dramatically and inflation is raising its ugly head.
So, is this a long-term crisis or a short-term blip and what should investors do? Should they stay loyal to their long-term investment principles and ride the storm out or batten down the hatches and run for safety?
The return of inflation means that high interest cash deposits are unlikely to offer good long-term returns for investors – particularly higher-rate taxpayers – but in the short term, seven per cent gross interest available from some of the larger institutions is quite an enticement.
Many investment managers are convinced that in three years, we will look back on the second quarter of this year as one of the great buying opportunities and curse ourselves if we miss it.
However, the same thing was said a few months ago and the markets have ratcheted down since then. If you crystallise a short-term loss by coming out of the market now, you then have to call when to go back in and this is perhaps even more difficult.
So if cash is not the long term answer and investing more in equities is a so-called “risky call”, where do you go for a return? Hedge funds and commodities have been the answer for the past few years but many hedge funds have struggled in recent adverse conditions and the strong bull market in commodities could be peaking.
Our advice, for those who have a long-term outlook and can afford to ride out some volatility, is to remain invested in the core assets of property, bonds and equities but with substantial global diversification. At the fringes of the portfolio, commodities in all forms, absolute return funds and emerging markets have their place but you need to be aware of the risk that returns from these areas may have already peaked.
The key is to keep on top of your portfolio and ensure that you are sufficiently diversified to meet your objectives over all time frames.
Ewan Pitcairn is a consultant with Scott-Moncrieff Wealth Management.
GO FOR A WELL CONSTRUCTED PORTFOLIO
As far as investors are concerned, for “credit crunch” read “volatility” and “uncertainty”, writes Morley Rowe.
But what drives this? Is it genuine economic conditions, speculators, rumours, media hype, or short-term decisions by government?
The answer is complex but possibly lies with who is making money at the moment. Take the oil industry. Surely with current prices, the oil companies are filling their boots. Or, are the oil speculators, through whom the oil companies buy and sell their oil, the ones making the money? Is the government making more money on fuel duty and VAT? Are papers selling more copies?
All this seeks to demonstrate is that you should not rush into making any snap decisions, which one could be led into doing in a credit crunch, because it will not be you that will profit in the long run.
The credit crunch highlights the need for a well constructed investment portfolio, one which takes account of your attitude to risk, time horizon for investing, income requirements and so on. This may sound boring, but it is true.
Such a portfolio places greater emphasis on asset allocation and wealth preservation and is flexible enough to allow tactical decisions to be made throughout the life of the portfolio.
You could consider giving greater emphasis to hedging returns such as absolute return/hedge funds and structured investments.
You could look to move your cash into fixed-rates due to the buoyancy created by the lack of liquidity in the market and the fact that banks are looking to raise cash from the retail sector.
You should also make the most of tax allowances where possible to maximise returns, and, if you need to change your investments, you could think about dripping money either into or out of the markets to reduce the impact of the current volatility. There is also nothing wrong with making bets now to cash in on the uncertainty, but be aware that if you do so, they really are bets, not investments.
Morley Rowe is regional director, Scotland and north-east England, Tenon Financial Services.
BANKS NEED CASH – SEEK OUT GOOD DEPOSIT RATES
A credit crunch occurs when banks find themselves unable or unwilling to lend money in the sort of quantities that they are prepared to lend in normal times, says Jeremy Beckwith.
Accordingly, loans are only available at very high prices and it seems banks do not want to lend even against solid credit risks. This is exactly the situation today, where the banks find themselves unable to raise money in the money markets at attractive rates, and are very worried about their existing assets and investments. They are also concerned about prospects for the economy and asset values such as UK housing.
The smart investor will conclude that there is a shortage of lenders and that therefore the returns to lending are high, but we are not all credit analysts.
Banks, though, are desperate for liquidity and will be falling over themselves to offer attractive rates, so it is a good time to shop around – trawl the websites and see where the terms that are best for you are to be found.
But be sure to read the small print, and remember that if anything were to go wrong, only the first £35,000 is guaranteed to be protected by the UK government (subject to conditions). After that, if the bank goes under, you could lose your cash.
With large amounts, a cash or money market fund is probably a better solution, where an expert manager will manage your money and other people’s, trying to find the most attractive short-term lending opportunities.
For those with more than £1m, a private bank like Kleinwort Benson can offer other cash-enhanced strategies to make that bit more from your money.
Jeremy Beckwith is Kleinwort Benson’s chief investment officer.
HEDGE FUNDS THRIVE ON HARD TIMES
The past six to 12 months have left even the most sophisticated investors confused as to the best approach in extremely trying markets, says Joss Mitchell.
Cash, at first glance, might seem attractive but the real risk taken on depositing with banks and institutions is probably unknown. Investors must also face the harsh reality that waiting in cash at current deposit rates, when taking into consideration real inflation, is probably negative. Knowing how to time entry into markets has historically proven to be very difficult.
Hedge funds provide an alternative way of investing to all asset classes. They can short the markets they invest in, can use leverage, are unregulated and have unfavourable liquidity terms. All of the above can be risks for investors, but are the main reasons why hedge funds can be flexible, creative and efficient from a risk-return perspective.
Because of the huge variance in management and the assets that the hedge fund managers invest in, there is a huge spectrum of returns. The most skilled managers can be accessed through a provider that has a deep due-diligence process, strong allocation and a good track record in managing hedge funds or fund portfolios. By creating a well-diversified but actively managed hedge fund portfolio, investors can capitalise in almost all market conditions. They can position themselves to take advantage of market dislocations, which provide the best risk-adjusted returns. By accentuating a need to hedge and protect portfolios in downturns, hedge fund portfolios can ride out short-term dislocations and capitalise on long-term downtrends, as well as position themselves for mis-pricings in the market.
Looking forward, bleak market conditions will provide plenty of opportunities for hedge fund managers who have shorted the right stocks and will continue to do so. Those that have been short on financials and long on commodity related plays have excelled in this environment. Those that can play volatility and take advantage of mis-pricings will have a far more open playing field. Managers that have their core competencies in corporate finance and understand the capital structure of companies will have plenty of opportunities when corporations start putting money to work and providing “corporate / M&A events” in the market that are uncorrelated with its overall direction.
Joss Mitchell is director of HSBC Private Bank, Scotland.
DIVERSIFYING PORTFOLIOS FOR CAPITAL PROTECTION
With rising inflation, gloomy forecasts for interest rates and soaring fuel, utility and food prices dominating the headlines, it is no surprise that confidence in the economy is faltering, says Mark Little.
The prospect of losing money in a banking collapse has heightened, and high net worth (HNW) investors have moved quickly to diversify their portfolios across a much wider spread of asset classes.
Our understanding that every investor is unique has led us to develop a highly innovative
investment philosophy using sophisticated profiling techniques to aim for investments that deliver market-leading performance in the way that clients want. In these turbulent times, this unique approach is proving to be a genuine differentiator.
There is a flight to safety, into cash and away from equities. Although a higher proportion of cash can be a comforter, with inflation looming and negative real returns in a number of major currencies – more so after tax – clients are keen to invest in index-linked Government bonds, hedge funds and assets where they believe they can achieve a return, even if a modest one. Nonetheless a higher allocation of cash empowers investors to take advantage of later opportunities.
Increasingly, investors are looking to have a greater part of their portfolios in investments that provide some element of capital protection. Switching out of traditional mutual funds, and segregated portfolios of direct equities, into structured investments that can alter the risk and return profile of their portfolio, is becoming increasingly prevalent
In these difficult times, the role of the investment manager takes on added importance with our advisers doing a lot more hand-holding and spending a lot more time talking to clients about what they can do for them.
While affluent investors are undoubtedly being squeezed through this credit crunch, it has meant that they are having to take a fresh look at their investments, reducing cash outlays, changing holiday plans or even downsizing the family car.
Similarly, HNWs are not immune; in particular there is evidence of a slowdown in sales of high-end properties, and this group of client is increasingly looking at other ways of diversifying their wealth and we are seeing a pick-up in interest in collectibles such as paintings, fine wines and even stamps.
Mark Little is regional director, Scotland, for Barclays Wealth.