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.