Jumping off the investment rollercoaster can be dangerous

By PHILIP MACALISTER

That old cliche about investing being a rollercoaster ride is one of the biggest understatements possible right now.

Investors are scared. Markets have been falling even more than they did in 1987. There's tension all around the globe.

President Bush is spoiling for a fight with Iraq, Israelis and Palestinians continue to kill each other, Pakistan and India are in a state of tension and topping everything are the so-called accounting scandals in the US.

If you have money in international shares it's quite possible that your investment has fallen by 40 per cent in the past couple of years. It's hard to lose that much without doing anything. To make matters worse, the markets now have to rise something like 50 per cent just to get back to where you were two years ago.

"You can see the fear in people's eyes," says Grosvenor Financial Services chief investment officer David Beattie, who recently completed a series of presentations to investors around the country.

"There's a lot more [fear] in Auckland than Invercargill, but it's there nonetheless.

"Investors are saying, 'I can't handle this any more, I have to get out'."

The trouble is it's dangerous to get off a rollercoaster in the middle of the ride, so you have to hang in there. But what do you do?

First, it's worth looking at the markets and putting things into perspective.

The issue of falling markets has become such a concern that a special session on the topic was a feature of this week's Association of Superannuation Funds conference in Auckland.

Three heavy hitters from the funds management industry presented their views and answered questions. One of the most surprising, or some may say gratifying, points was that all three - AMP Henderson investment strategist Paul Dyer, Alliance Capital equities manager Andrew Bascand and BT Funds Management chief investment officer Craig Stobo - agreed with each other.

"Stocks are very cheap relative to bonds," Stobo said.

He said an analysis of the markets showed it was not all doom and gloom and that people were being too pessimistic.

Dyer noted that for the first time in a long time investors were getting a good risk premium for investing in shares.

On the issue of shonky accounting, AMP Henderson has done an analysis which compared the official US statistics against what companies say they are producing. "Our sense is that there is not much rot below the surface," said Dyer.

Likewise, all three managers agreed sentiment was poor, mainly through media coverage of issues such as accounting fraud.

Dyer put some of the recent issues into perspective, saying, for example, that Enron didn't fail because of accounting fraud - dubious bookkeeping just hid the company's failure for a long time.

Stobo said evidence coming out of the US suggested that the economy was doing quite well.

For example, companies had just completed reporting results for the second quarter of the year, and almost two-thirds reported stronger earnings than analysts had predicted.

Although agreeing on the outlook, the three managers still saw some risks.

Is all this optimism just a case of managers "talking up their book"?

Only the future will tell, but one person who takes a contrary view is economist Gareth Morgan.

Morgan, speaking at the same conference, supported the "double dip" theory - nothing to do with Lotto, but just a way of saying that the US economy, which makes up roughly half of the world economy, has another fall ahead of it.

He believes it is "now more than probable" that the US market will fall further.

For one thing, Morgan is not convinced that company earnings will continue to rise. If he is right, then companies with falling earnings will also have weaker share prices.

The second piece of the picture is household spending. US consumers have to keep spending to keep the economy on track. They have been doing that admirably, but things could change as their wealth shrinks.

Morgan says household debt is rising and people are pulling money out of the market.

AMERICANS a ren't the only ones who are pulling back from shares. Kiwis appear to be doing the same thing, or choosing to put new money into other areas. Morgan's worry, which is shared by Beattie and other investment experts, is that investors are leaving the sharemarket and loading up their portfolios with assets which carry just as much risk as shares, and maybe more.

Among the list of investments they frown on are some types of property, fixed income investments such as capital notes and forestry.

One of their main concerns is that some of these investments have very poor liquidity, meaning they can be difficult to sell, and sometimes only at a heavily marked-down price.

Likewise, many of these investments aren't "marked to market" - repriced each day, as shares are. Instead, investments such as property and forestry are only priced when a sale is being done.

Beattie says if people valued their houses every day they would have sleepless nights when they discovered the price changed significantly.

The other big risk, particularly with some fixed-interest investments, is that investors are swapping what is known as "market risk" for "credit risk".

Market risk is the danger that the entire market will fall. That's the risk you run if you buy shares in a spread of companies.

When you buy something like a capital note, nearly all your risk is concentrated on the success or failure of one company.

While most companies don't get into trouble, some do - Fortex and Skellerup, for instance.

Beattie raises two other questions about some of these investments. One is how investors are paid out, and the other is whether they are being adequately compensated for the risk being taken.

In his view investors would be better off to buy the shares of some of these companies, rather than their fixed-interest offerings.

And, like many other people, he believes that these fixed-interest investments don't pay investors a high enough interest rate for the risk they are taking on.

But the question for many investors now is this: should I stay with shares, even though the outlook is uncertain, or is it time to bail to other assets?

M ORGAN paints a gloomy picture of the short term, but the long-term scene looks quite different.

Investors who want to succeed have no choice but to stick with shares, he says.

"If you believe in economic growth, then you have to own shares as they are the only assets that will grow. Debt doesn't grow.

"If at the end of the day you think you are going to get economic growth globally then equities will always provide the best returns. Always."

Morgan says he has switched his preferred way of owning shares from a passive approach to one that favours active management and stock picking.



Falling sharemarkets have highlighted another issue, says Beattie - the need to have a plan and to stick to it.

For example, if you started your investment programme aiming to keep 40 per cent of your portfolio in shares then it's probably time to buy more shares to bring the weighting up to this required level.

To put things into perspective Beattie draws on his 16 years' experience in the funds management industry.

"The best decisions we ever made on behalf of investors was when I had that horrible fearful feeling in my stomach. My emotions kept telling me don't do this but my head and the objective analysis kept saying the contrarian view that it was the right thing to do."

* Philip Macalister is editor of Asset magazine and online money management magazine Good Returns.

philip@goodreturns.co.nz