As Europe’s sovereign debt grows, here are my tips to help you choose an investment when the market remains unpredictable.
According to a recent High Net Worth Investor survey conducted by Investment Trends, fourteen per cent of investors with portfolios greater than one million dollars are accumulating cash and waiting for market volatility to decline. Ten per cent were reallocating to more diversified and less volatile investments with a further eight per cent actively transitioning their portfolios from growth to defensive investments.
This little piggy went to market…
When the four little PIGS (Portugal, Iceland, Greece and Spain) went to market (instead of staying at home), they raised seventy per cent of their sovereign debt from foreign investors, pension funds and commercial banks. Now, with fears of reserves rapidly running out, trepidation of a global debt pandemic has been reignited, sparking panic across debt, equity and currency markets. Many economists and strategists are even pronouncing the possible demolition of the Euro and European Union as a result.
Learning lessons the hard way
For new investors looking to enter the market, now is an interesting time. Although many feel the Australian economy is sheltered from the woes of the European market by our Asian neighbours…think again!
Yet if you firmly believe in long-term investing trends, you may also believe that despite the inherent volatility of the global markets at present, that certain assets remain sound long-term investments…
When I wrote this article, the S&P/ASX 200 was around 4,610 points, down roughly six per cent in less than two months from its end of March close of 4893. The index also remains thirty two per cent lower from its October 2007 close of 6754. So maybe Australian Equity is undervalued? All we can really do is protect ourselves against the economic purge of poor investment decision making, the best way to do this is still diversification. However, simply spreading your investments is simply not good enough anymore. If the GFC taught us anything, it’s that a global, systematic meltdown of all markets can and will occur. The forty eight per cent drop in the S&P/ASX All Ordinaries from its peak to trough cycle serves as a bitter reminder. More importantly, it has also taught us some very interesting lessons about creating appropriate and defensive portfolios.
How to behave in uncertain times?
Uncertainty over global market conditions is always present and isn’t expected to abate anytime soon. Since October 2007, volatility has become a natural part of our investing framework.
Diversification across asset types, spreading your investments globally and investing in different strategies are all great ways to protect your portfolio, but implementation is the key.
If you are simply looking to track the index, consider an index fund. It will deliver you a low cost alternative to an equivalent active fund. If you want to outperform the market, investing in actively managed funds and considering specialist strategies are the go. But if you plan to blend these strategies into what’s known as a ‘core and satellite’ investment approach, the temptation to over allocate to the higher risk specialist satellite strategies can be too tempting. The result, an over allocation to active investments that can significantly increase your risk and susceptibility to volatility.
The little Aussie battler
If you are diversifying globally, you can easily neglect the impact of currency risk on your investments. Even a mild increase in the Aussie Dollar can create a reasonable fall in the value of your non-AUD assets.
According to the Commonwealth Bank’s ‘Aussie Dollar Barometer’ which surveys exporters and importers attitudes to exchange rates, roughly 78% of medium sized importers expect the AUD/USD to rise.
So for those of you with un-hedged non-AUD investments, you’ll be pleased to hear that the average expectation is for the AUD to increase to USD94.6 by December 2010. Hmm?
Recently, the AUD/USD was at 0.8250 and is likely to face further volatility in the coming months. You can negate effects of currency volatility with hedging. Currency volatility can also be neutralised by splitting your investments across hedged and un-hedged investments. This can be done by splitting your investment across funds with the same investment strategy, but with a portion of your investment in the hedged equivalent.
The alternative is to retain a purely domestic investment focus and avoid currency risk altogether, but this presents an opportunity cost with its own risk trade-off.
A diversified investment solution
Finding the right investment solution is not easy, but for new investors, multi-sector multi-manager funds offer a simple and diversified managed investment solution. You can pick a fund with an investment objective and timeframe that is consistent with your own and let the fund manager do the rest. Multi-sector funds spread your investment across a range of asset classes and dynamically manage the underlying asset allocation as the market changes. Multi-manager funds pick the best managers, select complementary investment strategies and then blend them together. They also allocate to a predefined asset allocation, hedge out any currency risk and dynamically manage the portfolio of global investments for you. It looks like volatility is here to stay, for the next year or so, but investing doesn’t have to be difficult or time consuming. Finding the most appropriate investment strategy to suit your risk profile is the best place to start.
Happy investing!
