Market meltdown and property woes have brought defensive investment to the fore, writes CAROLINE MADDEN
THE CARNAGE witnessed in global stock markets since the credit crunch struck has taught investors a harsh lesson about risk and left many nursing substantial losses. With the threat of a recession now added to the mix, what defensive strategies can private investors adopt to survive the stock market slump? Should they ride out the storm in the hope of catching an upswing, or cut their losses now and hide out in a safe haven until it all blows over?
"There is always a point in time when cash is king and this is one of them," declares a distinctly bearish Alan Wolfe, senior consultant at IIB Bank, who believes that the economic downturn will be "deeper and more prolonged" than people imagine.
Banks have increased their savings rates in order to attract more deposits and bolster their reserves, and with one-year fixed-term deposit accounts now paying interest of 5 per cent, holding funds in cash has become a more attractive proposition.
"Right now you're being paid to hold cash," Wolfe says. "The deposit rate of interest you can earn will at least maintain the real value of cash."
Ian Mitchell, managing director of Deloitte Investment and Pensions, also believes this is a time for caution, and feels that cash will remain "a good place to be" for the next six to eight months.
However, Brian Weber, executive director at Citi Quilter, interprets the mass exodus to cash by both private and institutional investors as a "contrarian indicator" - ie, a bearish signal that opportunities exist in undervalued stocks. Weber expects the stock market to stage a recovery at some point in the next six months, and says that fortune will favour the brave. "I'd be very strongly advising people to start running the slide rule over equity portfolios," he says.
Investors should concentrate on non-cyclical stocks with low levels of gearing, high dividend yields, in defensive sectors such as food, pharmaceuticals, brewing and utilities, and should steer clear of cyclical stocks such as motor manufacturers and airlines, he says.
Meanwhile, Harry Nimmo, fund manager with Standard Life Investments, advises people to consider investing in smaller companies. These stocks tend to be economically sensitive and can be risky, so Nimmo recommends that investors look for smaller companies that can control their pricing environment and have recurring revenue steams, and avoid those involved in basic manufacturing.
For investors who have been burned by recent stock market volatility, but who equally don't want to leave their entire portfolio on deposit, what are the alternatives? Traditionally during time of stock market turmoil and economic uncertainty, commodities such as gold have attracted jittery investors looking for a safe haven.
However, gold is not necessarily the best port in this stock market storm. "If you chart the gold price over the last 100 years versus other assets classes, it's a dismal performer," Weber says. It's enjoying a "cyclical boom" at the moment so it's seen as a safe haven, he says, but gold is simply not a good investment over the long haul.
Eoin Kennedy of New Ireland believes commodities can serve a purpose as a hedge against inflation and a diversification tool, but warns that they can be volatile and subject to speculation, so investors should not risk too much of their portfolio on this asset class.
Weber dismisses the belief that commodities are a safe haven as a "popular myth". It was estimated recently that as much as 50 per cent of the demand for hard and soft commodities is being driven by financial markets, and the proliferation of commodity exchange traded funds (ETFs), securities that enable smaller investors to access this asset class.
"While there's huge demand for this stuff and it's capturing the public imagination, we would be totally contrarian on that," Weber says. He is not alone in predicting a commodities bubble is forming.
The two man are also at odds on emerging markets. Kennedy suggests these markets (such as developing countries in the Far East or the new EU accession states) present an alternative investment opportunity. "The subprime mortgage [ crisis] and the credit crunch have had almost no impact on these kinds of areas," he explains.
Again Weber takes a different view. Commodities and emerging markets have been running in tandem, because developing countries have been soaking up commodities to manufacture goods. The difficulty lies in the fact that the goods being manufactured are largely cyclical. "We think there's probably weakness coming in both those spaces," he says.
Another common place that investors seeking refuge from stock market turmoil is in capital-guaranteed products, which guarantee that they will get their original investment sum back at the end of a specified term.
Such products are currently enjoying a resurgence in popularity, but investors should remember that peace of mind comes at a price. In the case of capital-guaranteed products, this in usually in the form of a cap on potential returns.
What about the asset class that served Irish investors so well until its recent fall from grace? Is it time to tentatively re-embrace property and started sniffing around for bricks and mortar "bargains"? The experts are divided on this issue. "Don't try to catch a falling knife," warns Weber. He feels investors should bide their time before jumping back into Irish and UK property. "I would wait for more stability in terms of prices and more clarity in terms of direction."
Financial adviser Liam Ferguson says that, although property doesn't have the cachet of capital appreciation at the moment, high rental yields mean that a buy-to-let property in a good location can still represent an attractive proposition for the experienced investor. "I don't think anybody in their right mind would be getting into property now with an expectation of 10 per cent annual increases in their property price [in the immediate future], but at the same time if you can put together an investment where the rental yield is strong, then it is still attractive," he says.
Michelle O'Keefe, partner at BDO Private Wealth Management, suggests that before snapping up what may appear to be bargains in Ireland or the UK, investors should first ask themselves whether better opportunities exist further afield, for example in Asia, and possibly, in time, the US.
Another alternative to sitting on the sidelines until the current stock market turmoil blows over is to take "short" positions by betting that the price of shares will fall, rather the traditional approach of "going long", or backing winners. In this way it is possible to profit in a falling market.
A common method of going short is by buying contracts for difference (CFDs). These are highly risky derivative products that allow investors to speculate on share price movements without actually owning the underlying share. Investors are only required to place a "margin" of 10-20 per cent of their investment with the broker and borrow the rest.
However, the leveraged nature of CFDs means that any losses are hugely magnified, and for this reason CFD investors have been among the biggest losers during recent market volatility. They are definitely not for the faint-hearted or, indeed, for the occasional investor.
Spread-betting also offers the opportunity to go short, but again this is a highly geared and therefore highly risky strategy. Spread-betters can protect themselves to a certain extent by setting "stop losses", devices which limit the loss on a particular bet. Nevertheless spread-betting is not for the amateur - as with CFDs, things can go very wrong, very quickly.
Whatever strategy investors opt for, there will be a risk-reward trade-off - the bigger the return they want, the more risk they have to take on. According to Kennedy, the one exception to this rule is diversification. "You can reduce risk without reducing your return potential simply by spreading things around a little bit," he says.
BDO's O'Keefe echoes this advice: "The primary strategy that will minimise the impact of current conditions is to have a diversified portfolio."
