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.

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.

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.

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.

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."

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.

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.

Are Hedge Funds an asset class?

It has become accepted wisdom that Hedge Funds should be regarded as a separate asset class. They should have their place in a well-diversified portfolio next to the traditional asset classes of equities, bonds, property and cash.
While we certainly would agree that hedge funds have to be analysed and managed with special care we would like to disagree with the consensus.
What is being overlooked is the fact that the traditional assets are investment vehicles that (one hopes at least) produce a return over time that is not just the product of clever market timing. Equities pay Dividends, Bonds and Cash Deposits pay interest, Property gives a return in the form of rental payments.
When we look at the holdings of the average Hedge Fund we know that they contain elements of these asset classes. But one of the key elements of any hedge fund worth its salt is the fact that the fund might at any time be short any of these assets. It is basically a bet on the market movement. The bet is against other market participants with a different view and the net result is a zero sum game for the totality of those investors that hold these betting positions at any time.
It is certainly an exciting as well as a rewarding game to find those managers that are on the winning side. As in any human activity, there are always individuals that are better than their competitors at what they are doing. We only have to look at the Arts or Sport.
Timing of markets and asset classes is nothing new. Any investor who has all his money in cash for example, is 'short' the other asset classes. Hedge Funds are a new name for a more widespread use of market timing that also uses techniques such as derivatives, short selling etc more extensively. Very few Hedge Funds are really true to their name, i.e. hedging long and short positions all the time. Most have net long or short positions at most times. The new 'asset class' therefore can be anything to anybody at any time.
The main problem is, that - in contrast to the traditional asset classes - Hedge Funds to not introduce or rely on a basic inherent return (Dividend, Interest, Rent). The larger the number of funds, the more the investment returns (minus fees) generated by Hedge Funds overall will converge around a (possibly disappointing) average return.

How China managed to keep the Renminbi down

In a recent article in the Financial Times (11 October), Martin Wolf gave a good overview about the Foreign Exchange policy options that the Chinese authorities have. Interestingly, the fact that China is still a dictatorship was not mentioned. A totalitarian regime is able - similar to Stalin's enforced savings in order to industrialise in the late 1920s and 1930s - to suppress local demand and hoard foreign exchange reserves in a truly mercantilist fashion. These reserves may well be put to a good use at a later time - after all they will soon amount to nearly $1000 for every man, woman and child in this populous country. But this is of little help to those workers in the industrialised world that are priced out of the market by this market manipulation. The European shoe workers may well be inefficient but they do face unfair competition fostered by an undemocratic regime and any analysis of trade politics has to take this non-economic argument into consideration.

Euro- the Beginning of the End?

Exactly a year ago we referred to an article by Wolfgang Muenchau in the Financial Times in which he called in question the pricing of Italy's public debt.Only sensationalist journalists were at that time expected to call into serious question the underlying assumptions behind the Euro. A good friend of mine whose judgment is always very good remarked that a break-up of the Euro is not foreseen in any EU Treaty and could not happen.Now this is no longer accepted wisdom. The question is now: who would win, who would loose from any break-up. I always thought that the prudent thing to do - given the spreads in the Euro zone Bond Markets - would be to buy German Government Bonds. Whatever Germany's problems are at the moment, at a pinch we would rate its prospects higher than those of the other members of the Euro zone. Unless the governments start to steer a more prudent economic and fiscal course I predict that this provides a long-run one-way bet the like of which presented themselves only during the currency crisis and subsequent devaluations under the Bretton Woods regime of fixed but flexible exchange rates.