KEY POINTS:
We are in one of the worst bear markets since the Depression. Global stockmarkets were down by 40.3 per cent in US dollar terms in 2008 and the New Zealand market by 33.7 per cent.
Not good.
But fortunately, diversified portfolios usually own bonds, too, and these had a great year, reducing overall losses to about 18 per cent.
It was still possible, with a bit of effort and some expert financial advice, to do even worse than that. In fact, it seems like the smarter you were the more money you were able to borrow and the bigger your losses.
Similarly the better connections you had in the finance world the more exotic the products you gained access to and the greater your subsequent privations.
The year 2008 turned financial theory on its head: lower risk meant higher returns.
While there have been bigger busts before it is possible that today's disaster is up there with the worst in terms of overall wealth destruction because the portfolios of so many investors were leveraged in some way or another and even conservative investors had little in genuinely low-risk assets.
In New Zealand at the start of 2008 it seems that nine out of 10 financial advisers, when setting up the low-risk component of Mum's and Dad's portfolio, opted for finance company debentures.
So with the prospect of individuals recovering only 10 per cent or so of the face value of these toxic assets, and shares generally off by 30 per cent, many local investors will be looking at overall portfolio losses greater than 50 per cent in calendar 2008.
It hasn't been much better overseas. One of the key features of the investment scene over the past five years, apart from the terrible performance, has been the popularity among private bankers and those in the know of so-called alternative investments.
The conventional wisdom, up until recently, was that while it was acknowledged that shares were risky and bonds were safe a conventionally diversified portfolio's performance would be constrained by the low potential return of bonds.
Far better, said the consultants, private bankers and more or less everyone else, to replace the bonds with alternative investments which, the story went, would be just about as safe as bonds but give a far more acceptable level of return.
This sort of clever investment approach was pioneered by people like David Swensen of the Harvard University Endowment and various other luminaries whose historical record confirmed the good returns with low volatility story.
Alas it hasn't turned out so well for late arrivals to the alternative investment scene. Areas such as hedge funds, private equity, structured credit, property and commodities not only haven't smoothed out returns, they have often made things worse.
With the benefit of hindsight it seems that the only thing that goes up in a downturn is correlation: alternatives which had been marketed as having a low correlation with the stockmarket have tanked along with shares - in some cases leading the charge.
Today the alternatives model is discredited and is costing investors money. Indeed, big losses by hedge funds in the now illiquid alternatives market is being credited with some of the weaknesses in stocks - they were all you could sell at one stage.
The problem seems to be that correlation - the extent to which an asset class like property tracks the performance of another asset class like shares - is historic. Ancient history, more like, and from an investment strategy perspective, worse than useless. As someone once said, "It's better to know nothing than to know what ain't so".
Correlations are dynamic - they change. But investors just saw the historic correlation and piled into the uncorrelated sector, forcing prices up and prospective returns down.
Overlay the strategy with borrowing and, as has happened with oil, private equity, hedge funds and property, when people want to get out the price collapses along with a general exodus from risk.
A more profitable strategy might, in fact, be to employ the consultants and experts to determine the historic correlation and then do the opposite of what it tells you, on the basis that everyone else is buying it now and the data is thus misleading.
About the only true shelter in this storm has been the old favourites - bonds and cash, with long-dated US Government bonds returning their second-best calendar year performance ever at 41 per cent.
Private equity was the flavour of the month a year or so ago on the back of easy credit and low financing costs. So popular, in fact, you had to be well connected to get access to the best managers.
Today things are very different and the Financial Times reports that institutions are rushing to sell shares in unlisted buy-out funds for as little as 30 cents in the dollar. This is some reversal of fortune.
One can get an idea of the dire performance of private equity if one looks at the share price performance of the billion euro KKR Venture Capital Fund listed on the Amsterdam Stock Exchange.
This fund was floated by venture capital gurus KKR (Kohlberg Kravis Roberts) at the top of the private equity hysteria in May 2006 at 100. Today the shares are just 14. Similarly the London-listed Schroder Ventures, which is an investment trust investing in venture capital funds, fell by a massive 89 per cent in 2008.
It's a similar story with property. Listed property stocks around the world have plummeted, in some cases falling by twice the amount of the fall in their respective stockmarkets.
Property had the same problem as venture capital - it relied on low interest rates and readily available credit.
With many ostensibly low-risk property companies funded 50 per cent by equity, 50 per cent by debt, higher interest rates meant sharply lower dividends for shareholders.
Higher interest rates also meant much lower valuations of property. Thus, with lower rents around the corner the listed market anticipates property valuations down by 25 per cent which, with 50 per cent gearing, means shareholders take a 50 per cent hit.
What if anything can we learn from this mess? Three things come to mind.
There are no free lunches. Things that do well in the good times invariably dip out in the bad times.
Beware of high fees either at the point of product manufacture (CDOs, private equity) or distribution (finance company debentures). Low-risk products can't sustain high fees.
This is probably the most difficult. When the crowd buys equities, buy bonds, and vice-versa. If you find that too difficult then force yourself to own a bit of both, especially if you consider yourself to have a higher than average tolerance for risk.
* Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.
