Investment

According to T Bailey, the Nottingham based fund of fund manager, investors are better off being in the wrong fund in the best performing sector than the right fund in a poorer performing sector.  Or, put another way, your asset allocation will have a much greater impact on your returns than choosing the ‘best’ manager.

This will come as no surprise to anyone who has even a passing acquaintance to investment theory.  Even if all you do is check out a list of the twenty best performing funds over the last year, you will be struck by the fact that they all come from the same sector, be it China or Fixed Interest.  The sector of choice will, of course, change over time but more often than not there will be a flavour of the month.

It is slightly odd for an active fund manager to publish research which rather undermines part of their role but it does generate publicity and perhaps it is true, even in the world of finance that there is no such thing as bad publicity.

For many investors, it is always useful to be reminded from where investment returns come.  Get an asset allocation suitable for your needs and you are ninety percent of the way to successful investing.

If your investment manager does not share the same timescales as you, can they really deliver the performance you need?  When the tenures of fund managers are measured in months rather than years, it is no surprise that their strategies do not suit investors, for whom investment horizons may be measured in decades.

It is important for investors to realistic about the investment objectives set by their fund manager who is much more likely to be focused on their CV than most investors would believe.  To the average fund manager, an above average return every three years delivers headline grabbing performance for long enough to draw in more funds and to enable them to feather their nest; that career move will leave most of their investors way behind.  However, a good year followed by a couple of poor years does not give them the type of consistency most of them seek, however well it is marketed.

It is certainly worth being a little cynical when assessing the suitability of a fund or investment management service as moral can be sapped in the face of personnel turnover, often bottom of the list of selection criteria.

There is some evidence (courtesy of the IMF) that the economy in Sub-Saharan Africa is growing faster than the world as a whole.  Not by much but when you consider the considerable effort some of its governments put into preventing any growth, this has to be seen as good news.  It still lags behind the Developing World, taken together, but a case is starting to emerge for including the continent in a portfolio.  I expect that this resurgence is a little fragile; were China, for example, to lose its need for African raw materials, things could take a turn for the worse.

Also, despite the enthusiasm of some fund management companies, it is not an easy place to invest and the local stock markets will not have much capacity for major inflows of capital.  In investment terms, Sub-Saharan Africa tends to mean South Africa plus stocks in companies involved in mining, for instance.  The political risks are considerable in much of the continent and it is probably a long way off being seen as a new China were, for all its faults, the government is seen as stable and not wholly irrational.

It really is the time for a few well worn clichés, the world's stock markets are having a real roller coaster ride, at the moment.  It is by no means unusual but they seem to be taking their cue from the US and the sentiment over there is all over the place.  No one is quite sure how big a problem the sub-prime crisis is going to be but it starts at huge and goes up to cataclysmic.

The big worry, assuming that the financial system does not implode, is whether the US will slide into recession.  The government, in the form of the Federal Reserve Bank, is pumping vast quantities of cash into the system in the hope that it can prevent it seizing up.  In this, they are being strongly supported by the European Central Bank.

The financial system has shown itself to be remarkably resilient in the past in the face of some very worrying events but, for many investors, this is probably a time to switch off the computer and not look at values for a year or so on the basis that investment portfolios are for life, not just for Christmas.

They said it would be different this time.  Property developers assured us that they were not creating an oversupply and offices were being put up on the basis of being pre-let to a blue chip tenant.  So why is the press full of doom?

Well, the most comforting thought is that the press is always full of doom or over excitement, that sells papers and pulls in the viewers.  It is, however, possible that things are getting a bit sticky in the world of commercial property.  Perhaps some of those blue chip tenants will default in the face of falling profits.  Perhaps some of the retail tenants in shopping centres will go bust.

It is certainly the case that property has been performing perhaps a little too well over the last couple of years.  It is also worrying that it has been by far the most popular choice of fund for retail investors over recent years, driven, in part, by fear of equities and hype in the Sunday papers.

For investors with a long term outlook, there may be no more than a period of depressed values to worry about.  Many of those running for the exits will, no doubt, fall headlong into another, worse, problem.  Such is the history of market timing.

I know it makes me sound like an old duffer but I am sure fashions come and go quicker these days.

The latest must have investment accessory is the Inverted Index Fund.  These return the opposite of the index and allow investors a way of shorting.  There are not many ways for private investors to take advantage of a belief than an index (or other investment) will go down in value, other than not investing in it, so some will welcome there arrival.  A number of fund groups are scheduling launches, almost certainly in equities and commodities so watch this space.

Whether there is a place for these in the portfolio of a long term investor, I am not so sure, but they are certainly of interest.  Technically, many things are becoming possible and I am sure we have only just seen the start of much innovation but as investors we shall need to be careful not to be sucked into the hype.

If, however, you have been waiting for a simple tool to allow you to make money (we hope) from shorting, it may be that your waiting days will end soon.

It is all getting a little hairy in the markets at the moment; all major markets posted significant falls yesterday and the news may not be much better today.  Are we witnessing (or, for those of us with investments, experiencing) the final act in the credit crunch tragedy or merely another scene?  Also, what course of action should a rational investor take?

No one can be sure where this crisis is heading; quite a few problems have been brought to the fore but there may be more to come.  It is almost laughable now that, only a matter of weeks ago, our august politicians were focused on the rate of tax paid by Private Equity to the extent that they restructured our entire tax system in an attempt to penalise them.  Meanwhile, in the real world, things were going pear shaped.

Poorly diversified investors may have the least comfortable experience, particularly those poor private investors who held significant chunks of Northern Rock stock for no real reason.  Also, those with too large a proportion of equities may find themselves ruing their lack of investment spread and property looks set for a difficult period.

What is holding up?  Well, the bond markets, unloved of late, may find themselves viewed more favourably (especially government and high quality) and commodities may continue their climb.  But it seems, oddly enough, that emerging markets may emerge (pardon the pun) the real winners from this period of instability.  A year or so from now, they may look quite grown up, while some of the racier classes of investment, such as private equity, may look a little discredited (another pun?).

As ever, the advice to any investor is to ensure that you are properly diversified.  Do not get drawn into this year's must have (or have not) sector and only invest if you have a long term outlook.

The City and financial markets in general are often accused of short termism and with some justification.  Many of the current problems we are facing in the credit crunch are borne out of a misalignment of the interests of investment bankers and the shareholders in their banks.  As we approach bonus season, the problems are about to manifest themselves in the pockets of bankers who are set to receive less than they had hoped.

Bankers and traders are generally rewarded for their performance in creating profits during the course of the year.  This encourages highly risky strategies which may produce fantastic returns for a few years even if subsequent losses more than wipe out past profits.  The banker will not have to return previous year's bonuses, although they may lose their job.  The shareholder, on the other hand, may see all of their returns over the years reversed within a short space of time.

This is not a case of twenty twenty hindsight, it was eloquently described by Nasim Taleb in his book 'Fooled by Randomness'.  To anyone who had read this book, none of the recent turmoil will have come as a surprise.  The problem is that I think there is no chance whatsoever of a significant change to the way rewards are doled out in investment banks over the long term.  It is just not the nature of the beast.

With the 'resignation' of Chuck Prince of Citigroup this week, the pain being endured in the Investment banking world continues.  These things are relative, however.  No big player is walking into the sunset without a huge pile of cash for their efforts (supposedly, $95m for Chuck), which, I suppose, cushions the blow.

What is intriguing for the rest of us is how these organisations which shower the cream of the academic world with money to labour for them, suddenly wake up to find that they have mis priced something by billions of dollars.  Some of the investments they hold are now worthless.  They have also lent money to companies which bought investments, sometimes from the same bank, which are now worthless, so their loans are looking a little tricky.

By pursuing ever riskier and opaque strategies, they have wiped out years of profits in some departments in a matter of weeks.  It would not be so bad were it not for the fact that these institutions are well placed to spread the pain to the rest of us n the form of more expensive finance or lower returns on our deposits.  Also, they will bounce back more confident than ever and ten years, or so, from now we will see a very similar wiping out of much of the intervening profitability.

Is the stock market, as a whole, an inherently riskier place to invest money than the residential property market?  Now, I am not for one second suggesting that either is an appropriate place to put your money, although one or both may be, I am just opening up the discussion.  I am also considering the property market in investment terms rather than housing terms, no share portfolio will keep you dry through the winter or give you somewhere to show off your latest plasma TV.  These thoughts are probably, therefore most applicable to excess property investment, by which I mean a second property, a buy-to-let property or a house larger than your requirements, which you hope to sell to fund your retirement.

Firstly, what do we mean by risk?  It is, I suggest, unlikely that the stock market or the property market will drop in value to zero.  It is, of course, possible to make a bad choice of investment.  Some companies will go bust and some properties may become worthless, perhaps because of flooding or encroachment by the sea.  Now, you would be daft to buy a property without insuring it against these risks but most people will buy a share in a company without any corresponding insurance against loss (i may cover how another time).  This, then, starts to colour our view of the relative merits of the investments; we take more risk with our stocks, for some reason, than we do with our real estate.

The world of professional investors usually expresses risk in terms of the volatility of returns.  An investment which can deliver high returns with periodic big drops in values is considered to be riskier than an investment which is more steady in its delivery, even if they end up at the same spot.

So, how does volatility compare?  My main concern here is one of information delivery.  If you valued your share portfolio every year, it may not look particularly volatile and, indeed, in most years it would have gone up in value, probably even in 1987.  This is where the stock portfolio is at something of a disadvantage when compared against property.  You see, property is not valued by anyone, let alone the market (as distinctly opposed to an estate agent or even a surveyor) in anything like real time.  Depending on how often we move, a property may only be market valued, i.e. bought, once every seven years.  We may read in the press about the general sentiment but no one is able to rub our noses in its value in real time, minute by minute.  If you own a stock portfolio, you can watch it go up and down every minute of the working day, responding instantaneously to investor sentiment, and it can be frightening for some.

Also, I have referred to a stock portfolio as opposed to one stock, mostly, as it would not be rational to hold only a couple of different shares.  Diversification is easy with shares, not so with property as it is expensive and slow to sell, amongst other things.  

What of the returns?  Well, ignoring income form dividends or rent, which I gauge to be similar after costs, I think property and equities have probably delivered similar capital growth.  If you take into account transaction costs and the difficulties of diversifying across a number of properties, it may well be that a property portfolio has lost ground to a share portfolio.  What, though, will the next twenty bring?

It is quite likely that soon every conceivable investment niche will have been covered as Barclays has just launched an ETF tracking Timber and Forestry.  This fund will track the S&P Global Timber and Forestry Index and will come as a welcome relief by all those stressed by their lack of ability to do so.  Most, however, will not find their world rocked by this arrival but it does illustrate a trend, that of Alternative investments.

Alternatives, which include Hedge Funds and Private Equity as well as art and forestry, amongst others, have become much talked about in the last five years, or so.  Popularised by their successful inclusion in the influential Harvard Endowment Fund, they have spread out into many Wealth Management portfolios.  Their supposed benefit is high returns uncorrelated with equities.  There are one or two problems, though.  Firstly, as with all diversification, if everyone does it, the benefits of the diversification are reduced.  Secondly, any prospect for excess returns disappears when everyone piles in, certainly if you are not the first.  Harvard benefited enormously by getting in early and waiting for their imitators to pile in and drive up values.  Thirdly, what works for a multi-billion dollar fund with an indefinite timescale, may not work for those of us with fewer resources at our disposal.  Harvard went out and bought forests, not funds tracking the fortunes of forestry companies.  It is unlikely that forestry shares will exhibit the same characteristics in terms of returns and volatility as actual forests.

However, do not underestimate the power of marketing and investors desire to buy into a bandwagon after it has left town.  That is not to say that their may not be a place for it, it is just wise to manage your expectations.  For those with deeper pockets, their are funds which give access to forestry ownership, albeit with higher costs than Barclays iShare levies; currently a modest 0.65% per annum.