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Risk and returns go hand in glove

By unknown | Feb 05, 2008 | COMMENTS [ 0 ]

Isaac Moledi

Isaac Moledi

Imagine how bad things can be. Six months ago, everything was rosy - robust global growth fuelled by seemingly limitless demand from China and India, strong corporate balance sheets, record prices across most asset classes and enormous infrastructure spend anticipated in South Africa.

In the pursuit of growth, risk was ignored and any bad news was promptly swept under the carpet.

Today, there is despair as most markets enter bear territory, having fallen more than 20percent.

The sub-prime contagion sweeps from the US to the UK, Europe and the East with spiralling commodity prices threatening inflation targets.

Think also of South Africa's ongoing energy problem of load-shedding.

It appears that appetite for risk has disappeared and any bad news stokes further panic.

Though some of the facts have changed, emotion, as reflected by market moves, has been more volatile than the facts.

The difficult question is, what should investors do in the current onslaught?

Should they sell and avoid further losses or should they use this situation as an opportunity to pick up stocks at bargain levels, or do nothing?

Nic Andrew and Marina van der Lith, of Nedgroup Investments, say investors have had it too good - for too long.

They remind us that returns and risk are joined at the hip.

Over the last five years, risky asset classes - equities, property, private equity, emerging markets - have provided stellar returns with very few hiccups.

Investors have come to expect this as the norm, 20percent returns with single figure volatility.

The Nedgroup team says investors should regard volatility as normal and an unfortunate reality of seeking solid returns.

They say it is extremely tempting to try to sell before the market falls - and to buy again before the next period of appreciation. Though such a strategy would be enormously profitable and reduce much of the angst, very few managers are able to do this successfully.

"Research has shown how few get it right and those that do, require steely resolve and much patience," they say.

They say that significant market declines are common.

"Our broad view is that developed market assets are starting to look attractive and we favour South African equities and cash over property and bonds," said the Nedgroup team.

"The starting point should always be a thorough understanding of the reason for investing," the team adds.

For those looking for growth over the long-term, a reasonable allocation to equities remains appropriate.

It makes sense to diversify a portion of assets offshore. Investors need to be more realistic in terms of risk and return.

Though the temptation to try to time the market is significant, Nedgroup says it is very difficult to get right.

"A more relevant approach is to develop a sensible investment strategy based on clear objectives, and then stick to it. Human emotion is the biggest destroyer of value. Do not let it get the better of you.

"Change your investment strategy when objectives or personal circumstances change, not when investment markets go up or down," they say.


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