Tough Markets - A Reminder of Risk & the Benefit of Diversity

The last two weeks have seen the value of international stocks fall sharply as investors moved to the spectre of rising global interest rates.  As is often the case with stockmarkets, investors reacted quickly and suddenly to events that had been developing more glacially.  Analysts and commentators alike had been predicting that at some point markets would react to a number of pressures (interest rates being one of them – indeed we covered exactly that in our bulletin of 22 June).

Stock market performance over the last 4 years has been good.  Some of the strong performance has been fuelled by takeover speculation.  Recently, in particular, there has hardly been a week gone by when there has not been the announcement of a major acquisition in the corporate world.  More significant is the number of these takeovers that are being carried out by private equity companies, financed heavily by international banks and lenders.

Global interest rates have been low from a historical perspective and the cheap debt has enabled private companies to leverage up (borrow) enormously in order to buy out much larger public companies; for example, in May this year Cerberus Capital Management (a U.S. private equity company) purchased Chrysler for $7.4 billion (source: DaimlerChrysler Motors Company LLC 01/08/2007).

The fear now is that as the interest rate environment becomes less favourable, not only will the source of company acquisitions run dry, but the banks who effectively financed the deals, may find that they are unable to sell the debt on as easily as they have up until now.  Also, due to the increase in the cost required to service debt there is the potential for defaults and a re-rating of credit risk.

There is a sense among some that investors had started to ignore investment risk against the background of cheap debt and soaring stock markets (former head of the US Federal Reserve, Alan Greenspan raised exactly this point earlier in the year).  The downturn in stock markets and the uncertainty in bond markets pushes risk back to the forefront of peoples minds, which is not necessarily a bad thing.

With so much uncertainty then, it would be easy to become disillusioned with markets; but it‘s always useful to revisit your investment attitudes at times like this.  When valuations are soaring it‘s easy to get carried away and even greedy; likewise, in times of doom it‘s all too common to be overly pessimistic.  Our belief is that so long as you are prepared to accept the possibility that over short periods of time the value of your investment could fall, exposure to equity and bond investments should form part of your investment portfolio.  Equally, however, it‘s in times like the last two weeks that our belief in multiple asset class investing in re-affirmed.

Investing in differently correlated assets ensures that when stocks and shares fall, there will be a part of your portfolio that is not falling (or protected in some way).  We call this Multi-Asset Investing; but essentially it‘s simply a way of not having all your eggs in one basket – or to look at it another way – a country who‘s economic strength depends solely on the export price of coffee and banana‘s, is going to be more at risk of financial collapse than one that can also include tourism, cocoa and copper in it‘s sources of wealth.  Multi-Asset Investing will include property, commodities, structured products, fund of hedge funds, derivatives, cash and cash-like holdings, as well as equities and bonds.

If we look at the 5 days from 23 July to 27 July, the FTSE All-Share fell -6.2%, where as a Multi-Asset fund like the Insight Diversified Target Return Fund only slipped slightly by -0.4%, while our own Chartwell Cautious Managed Fund dipped just -1.3%.  Even the more aggressively positioned Chartwell Strategic Growth (which has nearly 50% of its value in equities) compared highly favourably against stock markets losing only -1.4%.  For longer periods of time, Multi-Asset funds generally aim to deliver ‘absolute‘ returns i.e. post a positive growth figure, regardless of market conditions.

In tough times we‘re reminded about the importance of diversification, and just as with risk, that‘s no bad thing.

[Source: BBC Online, Lipper (a Reuters company), Insight, Chartwell Group Limited, DaimlerChrysler and Financial Express]