Business Times - 04 Sep 2008
Meeting challenges confronting investors
THESE are difficult times for investors, when market volatility - while relatively tamer on a monthly basis - has ratcheted up from its lowest point in early 2007. The coast is far from clear. Forecasts of a market recovery are almost uniformly pushed back as the credit crunch eats into the real economy. It is at times like these that investors who have stayed the course nurse their wounds and those who have retreated to the sidelines in cash emerge looking good.
Among fund managers, in particular those who are proscribed by their mandates to only buy and hold shares, the temptation to use cash as a market timing and asset preservation tool is strongest. Merrill Lynch's monthly global fund manager survey found that the average cash weighting of global managers was nearly 5 per cent in July. While that may sound modest, bearing in mind that many mandates require fund managers to be almost fully invested, as many as 53 per cent reported they were overweight cash.
It is typically in bear markets that debate on the merits of relative and absolute return funds is revived. While in a bull market, investors are happy to measure their returns against a benchmark, in a bear market, beating the benchmark is cold comfort; what investors hanker after is a positive return at a minimum. Absolute return funds, however, entail a vastly different set of risks and expectations compared with relative return vehicles.
Long-only managers with an absolute return mandate would seem to wield an edge in the ability to use cash tactically. But while cash may boost short term performance rankings in a poor market, it raises the risk that managers may be caught wrongfooted in their re-entry into markets, particularly if the market recovery is sharp and sudden.
This was what happened in the midst of the Asian crisis when managers sought shelter in cash. In the sharp recovery in 1998, some funds lagged the index by more than 50 per cent.
Ultimately, managers should not stray too far from their mandates. Long-only managers' cash weightings are typically capped at modest levels mainly to provide liquidity for investors, who on their part would do well to ponder their asset allocations. After all, the choice of absolute or relative return funds should not be a mutually exclusive one. Absolute return funds, with their cash-plus risk and return profile, are likely to underperform in a bull market. Yet they could be a stabiliser in bear markets like today's.
As for relative return funds, managers increasingly have a range of derivative instruments at their disposal. Options, for example, lend some measure of protection or yield enhancement. There is also a new generation of exchange-traded funds, including short-only funds. Thus, while today's investment climate is indeed challenging, investors can take some comfort from the fact that professional managers have the benefit of an expanded toolkit of financial instruments.
This is a very unusual BT editorial. I need to move away from my laptop now and so will comment on this at a later time.