28 November 2008

Investment Fads

When is looks to be too good to be true there is probably something wrong with it.
We never claimed to be the smartest investor on the block but we always kept a healthy portion of scepticism about any new investment fad that became fashionable in the past few decades. Sometimes experience helps - for who among today's market participants (not to mention regulators) still remembers Bernie Cornfeld's IOS and the infamous Fund of Funds that he peddled in the early 70s?
So we always felt like a helpless country cousin when reading about the untold riches that could be made by so-called Structured Investment Vehicles (SIV's) that invested in credit paper and financed the stakes by issuing short-term debt in the money market. The idea was that this would offer a positive spread (not only due to a generally positive-sloping yield curve but also thanks to 'intelligent' hedging of all associated risks.)
Basically it appeared to be nothing more than blatant market speculation (with leverage added to spice up returns). We were left scratching our heads about how this could work as we knew how volatile markets could be over different cycles. But the scheme worked for a while - thanks to a gradual decline in credit spreads and availability of cheap short-term finance. The staff at these funds reaped huge salaries and bonuses and were quickly set up for life.
But the old saying - 'Genius is being long in a Bull Market' - is still valid. And the bull market in Credit Bonds ended in the Summer of 2007. Since then one of these vehicles after another has hit the rocks. The latest to make (negative) headlines was Sigma Finance where most creditors are facing complete losses when the assets of the SIV are sold next week.

26 November 2008

Are Governments more risky than some banks?

This is the question asked by a national newspaper today. The reason for this is the fact that the cost of insuring against the British Government defaulting on its outstanding debt during the next five years has surged to 100 basis points above Libor at one stage.
This is more than the premium charged to insure bonds issued by the stronger banks such as BNP Paribas, Commerzbank of Credit Agricole.
We do not think that a default scenario is very likely for the government debt of any major industrial nation but we think it is extremely unlikely that the money that you will be repaid with will have even close to the same purchasing power that it had when the bond was issued.
The loss in purchasing power will be the involuntary contribution made by bond investors to finance the politician's pet spending projects - especially on their clientele and hangers-on.

11 November 2008

Inflation Bonds not without problems

Investors looking for a safe haven for their funds and unwilling to take any risk related to investment in Equities are easily tempted to preserve the purchasing power of their savings by investing in inflation-indexed bonds.
These bonds promise to increase the value of the principal at maturity and the interest payments by an amount that is linked to an index that reflects the rise in a price index.
The problem is that the index is usually calculated by a government agency and the rules are set by the finance ministry in the country where the bonds are issued.
Governments in general have every incentive to produce a price index that shows that inflation is lower than it really is.
So it comes as no surprise that a recent study commissioned by the Daily Telegraph in the United Kingdom in Spring of 2008 has found that the Real Cost of Living Index is rising at 9.5 per cent while the official Retail Price Index is shown as rising at a rate of only 4.2 per cent.
This means that an investment in inflation bonds is - while being a sound concept in principle - potentially also a serious risk to the purchasing power of the investor and can only be seen as a partial solution to the preservation of capital in real terms.

15 October 2008

Causes of the Global Credit Crunch

It is too early to fully understand how it could happen that the World's Financial System got close to a global meltdown during the past 12 months. Some blame greedy bankers, others lay the blame squarely at the foot of the (US) consumers. Institutional Investors also appear entangled as they allowed managements too much leeway and even egged them on to pursue ever-more risky expansion plans. However, we tend to think that regulators - and their paymasters the politicians - may have to take a large part of the blame.
Unfortunately they are the party that is the least likely to bear the full cost of their mistakes. Shareholders have to suffer from dramatically shrunken share prices, scores of bankers have lost their jobs, or are about to in the near future. Bureaucrats are happily engaged in the blame game and are joined by academics and media people who often are also less than objective in their judgement.

14 October 2008

Life-Cycle Funds - no Autopilot to Success

These funds allocate their assets to a mix of underlying funds based on some parameters like the age or risk tolerance of an investor.
In recent years they have become increasingly popular with pension fund investors that are enrolled in defined contribution pension schemes and want to avoid having to make their own investment decisions on a regular basis.
Lifecycle funds - or their underlying investment rationale - can be of interest to the substantial independent investor as well as any financial plan should always take the age of the investor into account.
PBA helps you to look behind the label of the product. Not all lifecycle funds are the same as their allocation to various asset classes can vary substantially from provider to provider. The allocation may at times be totally unsuitable to the needs of the investor.

8 October 2008

The End of Inflation?

A number of economists have been deceived by the seemingly low rates of inflation that many countries have experienced during the past 10-15 years. But the hard fact is that thanks to the power of compound interest even a low annual rate inexorably builds up to a staggering loss of purchasing power over a longer time span. The US US Consumer Price Index for example has doubled during the past 23 years and the Dollar lost half its purchasing power as a consequence. And this does not take into account the fact that the data has been heavily massaged down for political reasons. The power of compound interest is such that even a low rate of inflation erodes the purchasing power of money at a frightening rate."

23 September 2008

Pitfalls of Day Trading

Modern Technology provides even the most humble investor with the facility to trade most markets in a way that until fairly recently was only available to investment professionals working for banks or investment management firms.
The dazzling array of real-time price and fundamental data displayed on the computer screen can easily become addictive. Watching the markets is like watching an exciting game of football that never seems to end....as long as you keep your money.
What many do-it-yourself money managers lack is the discipline that is essential in order to survive in the investment game.
While it seems to be easy to make money between breakfast and lunch most people lose money in this game. The charts promise instant profits: didn't this chart move up dramatically between 8 am and 10 am? Would it not have meant large profits to buy and sell then? How can I sit here and DO NOTHING while the market moves?
Soon the novice trader buys and sells at a rapid clip, positions are entered on a whim and - even worse - leverage is employed which multiplies losses if things start to go wrong.
And human nature does not help: winning positions are sold too quickly to pocket a profit while losses accumulate while the investor waits to 'get even'.
PBA will help you to resist the temptations of overtrading your account. If you are not willing and able to devote a substantial time to studying and following the markets you stand as much chance of succeeding as if you would try to perform open heart surgery on yourself.

9 June 2008

Warren Buffett bets against Fund of Hedge Funds

Fortune Magazine reports that celebrated investor Warren Buffet has made a bet that a selection of Funds that invest in Hedge Funds will not beat the performance of the Standard & Poor's 500 Index in the 10 years starting at the beginning of 2008.
The investor is confronted with a multitude of Hedge Funds (Single-Manager as well as Fund of Funds) that all claim to offer superior performance.
At the same time the Hedge Funds business is no longer a cottage industry run by a small number of maverick investors that could fish in a very large pond an chase market inefficiencies that presented themselves from time to time.
As Hedge Funds become mainstream market participants - and judged by the volume of transactions in the secondary market they may already have become THE market - it is very difficult for the Funds to offer out-performance as an industry.
There will always be individual manager that offer superior results - but that is the same with individual shares where there will be rising shares in all market environments. But the trick is to find these managers.