Business

Saturday July 4, 2009

Forward and backward

COMMENT BY TAY HAN CHONG


APPROACHING 40 years of age, it suddenly struck a chord in me: some of us have probably lived more years of our lives than there are years more to live! But how many of us actively apply knowledge and experience gained for the betterment of our lives going forward? I am not in the position to comment on personal aspects but I probably have a little exposure to share my two cents’ worth where investment is concerned.

In the last four decades, markets have seen not one but a series of financial crises of various degrees of severity, i.e. Russian Rubble, Tequila Crisis, Asian Crisis, Technology Crisis and today, the Credit Crisis. Gold prices have literally soared! Although the cause of each crisis was somewhat unique, the response of investors and markets was fairly consistent.

Financial experts have written much about each crisis and provided advice on how to cope, preserve capital or manage loss. Yet, time and again, investors continue to be burnt in their bid to make some money. So on reflection, I would like to share a note on investing – it is about learning a “correct” lesson, only to find that it was “wrong” when applied to a more recent period, then be re-convinced that it is ultimately the “correct” lesson again sometime later.

Just in case I speak too much in riddles, let me explain what this important investing lesson is. It is about diversification.

Yes, I have written previously on this topic, and so have many others. We cannot emphasise enough on its importance – which simply means that investors should invest in different securities and assets of differing risk profiles. Regardless of the market environment, some assets will always do better than others. Well, almost every time!

My earlier learning was very simple and it really started with the Asian financial crisis in 1997-1998 and the popping of the technology bubble in 2000-2001. Asian equities and technology stocks were red-hot assets and most clients were too overweight on them when the crisis hit. I too was a victim! I still keep one small holding in technology which had lost half its value at the worse time but is somewhat close to the original investment value now. This was a “lesson” to me not to be too concentrated in any one asset.

While I am convinced about diversification, I admittedly had some doubts during one short period recently. This was just after Lehman Brothers had gone belly up. At the time, all the markets seemed to go down together without exceptions. There was absolutely no place to hide. The balance between equities and bonds had been the classical type of diversification. But that was not meant to be, as bonds suffered an equally bad or even worse fate compared to equities.

Of course, on hindsight we know that this round of shock was triggered by a credit crisis that translated into a global recession. As such, it is natural that bonds and credits are also hard hit.

From a financial crisis to a crisis in the real economies, it seemed almost like a domino effect that almost every asset class fell – commodities, oil, real estate. It seemed that cash was the only hiding place and even so, cash is returning a negative real rate of growth today compared to inflation. It is easy to question the advantage of diversification at this point.

But there is one saving grace. Interest rates are now at an all-ti me low. Governments have been pump-priming and liquidity had been injected into the banking system to stimulate lending. All these while the economies worked out its past excesses and leverage. There are tentative signs of slowing contractions with some possible recovery in sight, perhaps hopefully by end of 2009 or 2010.

As I look forward to the recovery in time, and re-calibrate the strategy for investing, I have come to a basic conclusion once again, that diversification is critical as risk drivers cannot be the same for every asset class. Some assets will benefit from the current situation better than others to recover faster. I would thus update this diversification story with some refinements:

(1) Extend beyond just equities and bonds. They are fundamental asset classes but they depend on a company (or country in the case of bonds) being a going concern. When one goes bankrupt, both bets are off.

(2) Add in real assets. Real assets are what I define as commodities and real estate. Commodities are wide ranging from oil to precious metals, base metals to agriculture, etc. Real estate is also wide ranging from residential to commercial to industrial and they are also very geography sensitive. Access to real estates can be in the form of unit trusts or even direct exposures via real estate investment trusts or REITs, buying a small plot of oil palm land or investing in properties locally and overseas.

(3) For high net-worth investors, they may selectively consider alternatives such as hedge funds, foreign currencies and derivatives. Despite the negative publicity over hedge funds and derivatives, these may continue to be valuable as risk diversification tools. Of course, we have to be very careful in our choice and be wary of promises that are too good to be true.

(4) Other than such different assets, it is important to take stock of one’s portfolio regularly. Treat the portfolio like a plant, it takes regular tending, trimming and pruning to ensure that it continues to grow well. A good portfolio should be able to withstand market shocks, but it may need to be reinforced to help it stand better.

So, although a diversification plan could have worked or did not work well in the past, it does not mean that it would be relevant or less valuable in the future. I believe in looking backwards to learn the right lessons and then focus on going forward.

However it doesn’t mean blind application to the next situation that arises as every problem is likely to be unique. But experience provides the ammunition for versatility in handling the situation to the best way possible. I strongly believe that it is still early in the path to recovery and this may be just as good a time to get some exposure to achieve long-term profits. But let’s do it in a diversified way, just in case.

● Tay is senior vice-president and senior head of UOB’s personal financial services division.

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