Shares

Many investors in shares are wondering how they should respond to the current volatility in most Stock Markets and the fear that 2008 will be as troublesome as last year, if not more so.  The answer to this really depends on why you are investing and for how long.  Many cash rich emerging nations, such as Kuwait, China and Singapore, and other wealthy investors are greedily gobbling up almost anything we are selling at a knockdown price.  They have very long time horizons and very deep pockets.  For them, the prospect of picking up stakes in some of the developed world’s finest financial institutions at five year lows is too good to miss.

I strongly suspect that many guardians of public wealth in the UK, for example, company pension funds, are eager sellers and may well have proved once again to have sold at exactly the wrong time whilst buying into, probably, bonds at the wrong time as well.  Like second rate defenders in football, they seem destined to rush time after time towards the player with the ball only to see it deftly passed to another who has space and time.  Oh, the humiliation of it all.  Meanwhile, much as the England Football team are often found to wanting custodians of the hopes of a nation, the trustees responsible for around £1 Trillion of the public’s money are wrong footed by foreign operators to whom they gave the game in the first place.

Where does this leave the rest of us?  Well, if you are investing in shares you really ought to know that they will not deliver stellar returns year after year and sometimes suffer losses from which they can take quite a while to recover.  It makes sense to diversify your investments away from shares alone, this is generally held to be a sensible strategy but you should ask yourself about how long you intend to be invested.  If, like Kuwait, you expect to be an investor indefinitely, then, perhaps, you should not worry about how poorly things are going now but wonder whether you are in a position to buy something on the cheap.  It is odd how discounts in shops turn us into buyers and discounts in stock markets turns us into sellers.

Now may be a good time to reflect on whether you have the stomach for stocks at all, there is no shame in admitting that they hold too much fear.  Fear and greed need to be kept in balance and shares can be more scary than, for example, fixed interest investments.  What is wrong with holding index linked bonds?  They may not offer the prospect of much real growth but you may be able to sleep at night.

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.

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.

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?