Third quarter mutual fund roundup: Buy, buy, buy!
October 11, 2008 on 2:14 am | In Money | No Comments
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Withdrawals from mutual funds that invest in emerging markets soared in the third quarter as investors sought refuge in safer assets. But amid the market mayhem, many equity fund managers saw reason to be optimistic. Their message: Buy, buy, buy!
Investors pulled $24 billion from emerging market equity funds and $11 billion from bond funds in the three months from July through September as financial storm clouds continued to gather, according to EPFR Global, a group in Boston that tracks fund flows.
Some of these markets registered their worst declines ever during the quarter. September marked the fourth consecutive month of decline in the Russian stock market, the second-longest period of decline in its 13-year history, excluding the aftermath of the 1998 debt default. The benchmark RTS index lost 26 percent in September and a substantial 50 percent since its peak in May. The Central Bank of Russia estimated that net private capital outflows from the banking system and other sources amounted to $16 billion over the quarter.
Europe equity funds, meanwhile, extended their losing streak with withdrawals of $7 billion in the quarter. The financial stress on the European financial system was reflected in the poor performance of funds invested in the region. Data compiled by Morningstar, the funds data group, indicate that the average European equity fund shed more than 5 percent of its value in the three months through Sept. 30.
There were, however, pockets of good news. French equity funds pulled in $900 million in August and September - a surprise development that many observers attributed to the “Sarkozy effect,” or optimism about the policies of President Nicolas Sarkozy.
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“The sense that the president's taxation and labor relations policies will be positive for domestic equities seems to be an important factor in the fund flows,” said Brad Durham, an analyst at EPFR Global.
In spite of equity market turmoil and the failure of U.S. policy makers to agree quickly on a $700 billion rescue package, U.S. equity funds pulled in a net $39 billion during the third quarter. This was less than the previous quarter, which saw inflows of around $55 billion, but it appears to indicate that not all investors were cashing out because they feared Armageddon.
“Substantial flows into U.S. large-cap value funds suggest a flight to quality,” Durham said. “The U.S. remains for many investors the safest option in an uncertain world.”
This is a paradox that will not escape the many investors who lost money on their U.S. holdings: The average U.S. mutual fund dropped 6 percent over the quarter, according to Morningstar.
It was a good quarter for China funds, which attracted solid flows in the range of $2.8 billion. Vincent Strauss, director of Comgest Magellan in Paris, has been avoiding China since late last year, but his instinct now is to load up on consumer stocks, which “look attractive at current levels,” he said. “Consumer goods manufacturers are attractive as they will benefit from the falloff in raw material prices.”
Strauss is doing his homework before making a move.
“We want to avoid investing in companies where major shareholders have borrowed to invest,” he said. “The last thing we want is to be at the mercy of forced sellers.”
While few fund managers are prepared to predict the bottom of the market, they expressed a feeling that when buyers come back, they will be seeking quality. History has demonstrated that previous emerging-market sell-offs - in 1994 after Mexico devalued the peso; in 1997 after the Thai baht devaluation; in 1998 after the Russian sovereign debt default; and in 2001 after the Sept. 11 attacks in the United States - were all opportunities to pick up emerging market equities on the cheap.
Derek Hong, a senior fund manager with National Bank of Abu Dhabi, believes that now is the time to “load up the truck” to take advantage of a great investment opportunity. Hong favors Arabtec Construction, which trades at a modest price-earnings multiple of seven and boasts revenue growth of 60 percent. Arabtec, Hong said, “will eventually find buyers once the markets settle down.” Hong also likes four other Gulf stocks - Dubai Financial Market, Gulf Navigation, First Gulf Bank and Sorouh Real Estate - because he thinks they are likely to show “very significant” price appreciation over the next 12 months.
Jacob Grapengiesser, a senior fund manager with East Capital, an emerging markets specialist based in Sweden, is backing Russia. “Russia has been punished severely for perceived political risk,” he said. “But the government is aware of the problems and doing everything it can to get the market back on track.”
Lessons in dealing with volatility
October 4, 2008 on 8:14 pm | In Money | No Comments
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The extraordinary volatility gripping the markets culminates a year in which wrenching price swings have become almost commonplace. Stocks, bonds, commodities and currencies have made moves in minutes and hours that in normal trading only occur over the course of days or weeks.
Investors, well off and humble alike, must cope with the turbulence, but those in the first group often pay professionals to do the coping on their behalf. Private bankers, uptown financial planners and others who cater to wealthy clients employ various strategies to help insulate them from, or even profit by, extreme volatility.
The safest approach is to try to sidestep the ups and downs by maintaining especially well-diversified portfolios. Further insulation can come from adjusting holdings to limit exposure to inherently more volatile asset classes, like stocks and commodities, and increase investment in high-quality bonds and cashlike instruments, which normally have smaller fluctuations.
“A very broad-based asset allocation” is the first step in dealing with volatility, said Chris Cordaro, a partner at the financial planning firm RegentAtlantic. He acknowledged, though, that when conditions become acutely difficult, as they have been lately, and volatility spikes, diversification becomes less effective.
“Correlations go to one in a crisis,” he said, meaning that everything goes down together. But they do not stay down for long, he assured: “Coming out of this, diversification is going to work, so there's no reason to abandon it.”
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Rather than trying to parry away the effects of heightened volatility, many advisers tackle it head on in various ways. A safe, straightforward approach, one that is available to investors who have modest portfolios and no outside help, is to rebalance the weightings of various investments.
It is essential when building a portfolio to establish risk parameters and allocate money to different assets accordingly, said Harold Evensky, a financial planner at Evensky & Katz. As markets rise and fall, certain holdings will occupy greater or lesser proportions of the overall portfolio than desired, a process that is exaggerated when volatility rises.
Rebalancing involves adjusting the weightings to bring them back in line with the original plan. An investor who wishes to maintain 55 percent in stocks and 45 percent in bonds, for instance, might sells stocks and buy bonds whenever the ratio goes to 60/40 or do the reverse when it hits 50/50, Evensky said.
That is one way to get the preferred result. Another, said Brett Hammond, chief investment strategist at the fund manager TIAA-CREF, is to do it periodically, say every year or two. “But whatever rule people follow,” he advised, “they should look at their portfolio now because it is likely to look significantly different from how it looked a couple of years ago.”
Another way to manage volatility is to treat it as an asset in itself. There are securities, amounting to cocktails of derivative instruments, that provide higher returns when markets have endured big swings and investors anticipate more of the same.
These structured products, as they are known, are created by investment banks and are not publicly traded. That usually makes them available only to wealthy investors.
Alexandre Zimmermann, head of advisory and investment solutions for SG Hambros, a British boutique private bank, has been increasing his use of structured products since the beginning of the year as a way of “selling volatility.” One vehicle he mentioned pays 10 percent a year for three years as long as the FTSE-100 index of British stocks does not end the three-year period 50 percent below where it started.
If the index does drop that much, investors will be on the hook for the loss, he said, but that would have been the case if they had simply put their money in stocks. Mitigating the loss is the 10 percent they would still pocket for each year that the index did not experience that steep decline.
The protection comes at a price, Zimmermann said; investors are giving up any gain in the index. But he said his clients did not mind.
“They are happy to move from a capital-appreciation strategy to an income strategy while keeping the same underlying risk,” he said.
But it is precisely because the climate is so iffy that Cordaro, the RegentAtlantic planner, would think twice about using these vehicles. They work only if the banks that invent them, and take the other side of the trade, pay up, and that is by no means certain these days.
“With the whole structured-products market, you've got counterparty risk,” he warned. “That was extremely evident” last month.
One way for small investors to avoid counterparty risk and profit from volatility is to sell exchange-traded call options against stock they own. In return for cash, shareholders take on an obligation to sell their stock at a fixed date and price in the future. Volatility is a significant component of an option's price, so this strategy is likely to be more profitable in a climate like today's, all else being equal.