Variables – and vagaries – of personal finance

Recovery from global recession has proved slow and sporadic, and Japan last month announced it had relapsed into negative growth, signaling, if not alarm to investors everywhere, at least renewed conservatism. 

The Japanese announcement came unexpectedly, a bracing antidote to broad hopes for a steady, if plodding, recovery from years of slow to no growth.  

Tokyo’s third-quarter 1.6 percent contraction in the world’s third-largest economy – after the U.S. and China – came as housing and business investment declined in the wake of a sales-tax hike, and mimicked similar difficulties in Beijing and the Eurozone, which registered a mere 0.2 percent growth in the July-September period. 

The contraction, according to local financial analysts, mandates a careful, if steady-as-she-goes attitude for investors, marked by a few bright spots, but largely reliant on traditional financial advice: Create a broad-based portfolio of investments that will minimize risk, limiting losses and balancing them against modest gains. 

“There is nothing exciting about sound long-term investing,” says Scott Elphinstone, managing director, chief investment officer and founding partner at Five Continents Financial Limited. “It is about doing sensible things with your money over a long period of time, turning off the noise often created by the media.” 

He says the portfolios he creates for clients ranging from individuals and trusts to entire insurance companies and even the Fidelity Pension Plan, are “well diversified” and include bonds, global equities and hedge funds. 

“In our view, diversification reduces risk,” he says. “It is the overall asset mix of the portfolio, not what individual securities you are invested in, that determines most of your return.” 

Advisers at Butterfield Bank agree: “In considering the myriad of investment options available, their returns and potential risks, it is crucial to build a balanced portfolio of investments that will minimize risk and improve overall returns,” say Bruce John, head of private banking, and Monique Frederick, senior portfolio manager. 

Presenting a pie chart divided evenly among five investments, the two recommend “a fully diversified portfolio … broadly … categorized as a mix of cash, bonds, stocks, real estate and private equity.” 

Cash, they warn, is probably the least attractive option as deposit rates are at their lowest in 50 years, “paying less than 0.5 percent per annum for one year and 1.2 percent per annum for three years.” 

With inflation at 1.6 per annum, they say, interest income will be eaten by inflation, meaning you are likely to end up with less money than you started with. 

While some cash is important for emergencies, stocks, they say, “provide greater potential for higher returns” although they “can be quite volatile and not necessarily appropriate for someone who may need the funds in the short term.” 

In the long-term, however, stocks “can be ideal … to achieve growth in a portfolio,” John and Frederick say, while outlining four questions any investor must answer: “your ability to ride out the volatility; your preference for growth versus income; your investment time horizon;” and, finally, and only half in jest, “your ability to sleep at night.” 

 

Mega caps  

While the two offer no specific recommendations, European financial columnist and investment analyst Juergen Buettner has a great deal to say. 

Calling New York’s record-setting Dow Jones index a bellwether, he says “as long as the upward trend of the market is not broken,” U.S. stocks will remain “interesting.” 

“Extremely loose” monetary policy, he says, “dominates everything,” and low interest rates benefit risky assets like high-yield bonds and stocks. 

U.S. airline stocks, once a dicey proposition, are experiencing “a comeback, a trend that could persist, especially if oil prices stay low,” Buettner says. 

More good advice, especially for retail investors, he says, is mega caps. Once known as “blue chips,” mega caps are companies like ExxonMobil, Apple, Microsoft, Nestle and IBM, with a market capitalization exceeding US$100 billion. 

Mega caps were traditionally dominated by American, European and Japanese companies, but since 2011 three Chinese companies – PetroChina, the Industrial Commercial Bank of China and China Construction – have placed among the world’s 10 largest. 

“These companies with a very high market capitalization often perform better in the second part of a bull market,” Buettner says, “and after a long period of underperformance, they are also currently cheaper than the small and mid caps.” 

In contrast, one-time mega caps that are now “extremely unloved” and that have lost significant ground are commodity traders like Barrick Gold, Rio Tinto or BHP – formerly Australia’s Broken Hill Proprietary, the world’s largest mining company – that deal in oil, iron ore or gold. 

Other losers, according to Investopedia.com, are some of the biggest U.S. and European banks in the wake of the 2008 global credit crisis. 

 

Frontier markets  

Similarly, investments might profitably be placed in “frontier markets,” a smaller, if less expensive, version of emerging markets. “Frontier” describes stocks in smaller, less-accessible, but still “investable” countries in the developing world. These “pre-emerging” equity markets, Buettner says, “are typically pursued by investors seeking high, long-run returns, and are less dependent on conditions in other markets, isolating them to some degree from extra-territorial buffeting. 

He points to such examples as Argentina, Estonia and Lithuania, Jordan, Romania and even Trinidad. The Morgan Stanley Capital International index lists 26 “frontier” states, although the roster can change rapidly as economies slip in and out of relative political stability, gain “emerging” status or even losing their reputation for bargain prices as investors crowd the market, driving up rates. 

Another trend is for companies, especially in the U.S., to buy back their own shares from the public. The spending spree, Buettner says, often boosts prices. 

 

M&A  

A variation on this theme is mergers and acquisitions, which, he says, are booming. Buettner points to mid-November’s $66 billion merger – billed as “the year’s biggest” – of pharmaceutical companies Actavis, the world’s third-largest generics prescription-drug manufacturer, and Botox-maker Allergan. Actavis is paying $219 per share for Allergan, and predicts a rise to $400 in 12 months to 24 months. 

“Low interest rates are helping fuel the current mergers and acquisition boom,” Reuters reported on Nov. 19, while hedge fund managers said they expected “the pace of consolidation to pick up next year.” 

Buettner, in an elegant understatement, suggests “one could make a lot of money,” and predicts that “more takeovers should follow.” 

Finally, he said, companies like Apple, EMC, Dow Chemical, Dupont, Yahoo, AOL and Ebay have “active investors” who seek management participation. “Their goal is, with the help of often short-term measures, to increase the value of a company. As the past shows, they often succeed.” 

 

Cayman stocks  

At a local level, Elphinstone says Cayman stocks are a good alternative. 

“The local companies whose shares trade on a stock exchange make sense to consider as part of a global portfolio.” For example, he cites Toronto exchange-listed Caribbean Utilities Company, which “has a customer share-purchase plan, the terms of which are attractive.” 

A little more speculative, he says, might be “investing in a small public company that you know well or a private company run by a friend. That can be exciting.” 

Butterfield’s John and Frederick embrace the idea of entrepreneurship, whether the business is self-owned or otherwise. “For an entrepreneur, business ownership is often [his/her] largest investment” and should be included in any financial plan. 

“Whether you own and operate the business, hold a partnership or share interest, or simply seek to invest in a private business,” the writers say, investors needs to consider the nature of the business, their own expertise in the enterprise, the expertise and reliability of the company’s senior management and staff, the financial strength and future prospects of the business, any potential additional capital requirements, projected return on investment, the liquidity of the investment should a sale become necessary – and what price might be appropriate, any tax consequences, and the anticipated length of time for holding the investment. 

 

Speculative investments  

“You could also set up a trading account and trade derivative securities like commodity futures,” Elphinstone says. “That can be fun and you might make some money on it. 

“With these speculative investments,” however, he cautions, “you need to be prepared to lose it all. 

“The danger is [that] you invest too much in this type of investment hoping to get rich. That rarely works. Investing is about staying ‘rich,’ not getting ‘rich.’ 

“As a result,” he says, “it only makes sense to put in a small portion of your portfolio” into speculative investments. 

Local bonds are also a good alternative. “The Cayman Islands government does have a bond that trades with a 5.95 percent coupon due Nov. 24, 2019,” he says, but adds, “Trading is in amounts that are often too large for the average investor.” 

 

Bonds  

John and Frederick agree that bonds are a good choice, and recommend a careful balance of equities: “Bonds are a great option given that they pay interest to the investor on set intervals.  

“Compared to stocks, bonds bring a bit of stability to a portfolio as bond prices fluctuate less than stock prices. They also have a tendency to move in the opposite direction from stock prices, providing a hedge against a downturn in that asset class,” the pair says. 

Because they are sensitive to interest rates, however, bonds lose value when rates rise. While that seems a distant danger for the moment, they must be monitored. In aggregate, the writers say, “potential return from bonds is generally lower than the expected return on stocks and may not provide sufficient returns to meet the objectives of clients seeking capital growth.” 

As they posed four questions regarding stocks, they pose five questions for bond investors: the need for regular income, current and anticipated interest-rate changes, how much they will yield until maturity, the time until maturity, and inflation. 

 

Real estate  

Finally, pretty much everyone agrees that local real estate is an excellent choice, with the caveat, says Elphinstone, that “the danger is borrowing too much to buy it. 

“As long as your debt is easily serviced and you anticipate a long-term holding period, you should do ok.” 

Bruce and Frederick offer a prescription – and the usual list of salient queries. 

“Your primary residence is not typically considered an investment, but for many it can be their largest investment and should be treated as such when establishing a financial plan. 

“When investing in real estate in addition to the family home, one must take into consideration: the type of investment property i.e. raw land, residential, commercial; salability/rentability; [the] condition and cost to renovate/repair; monthly carrying and maintenance costs; cash flow and return on investment; liquidity in the event you need to sell quickly and at what price; tax consequences, if any; investment holding period; and diversification by type of investment, geographical location and tenant make-up.” 

 

Cayman’s economy  

Elphinstone indicates that overall, Cayman looks like a good medium-term bet. “Even with the U.S. economy growing at a more moderate pace, the Cayman tourism sector should make some good improvements this year. Financial services are a harder call. While I think a decline is highly unlikely, even with all of the new regulations, my guess is slow growth is most likely.  

“As at the end of 2013, the GDP of the Cayman economy is still below 2007 levels and growing at a rate below 2 percent per year, much slower than the U.S,” he notes. 

Figures from the Office of Economics and Statistics bear out Elphinstone. The agency pegs 2013 GDP at $47,415 per capita, a 1.2 percent increase from 2012, but still lagging 2007’s high of $48,744.1, which was followed by three years of contraction. 

“We should never forget that the very high debt levels in many industrialized countries, and the desperate attempts of the leading central banks, signal that we are still walking on very thin ice – even more so with political crises like Russia-Ukraine and the Islamic State militant group,” Buettner says. 

“If the ice breaks … we will have to fasten our seatbelts, since all traditional countermeasures to fight crises are more or less exhausted.” 

 

Risk management  

Risk management, he says, “is more important than ever.” Markets have so far discounted political problems, and stock prices have climbed, but, Buettner reminds investors, economic growth and rising stocks “do not necessarily go hand in hand.” 

“As long as the market participants do not lose their faith, the best advice is to let profits grow. But if the mood changes and the upward trend is broken, investors should have their hedging strategies in place.” 

The last word goes to Butterfield Bank: “The ideal asset mix is never static, and should be reviewed annually and adjusted as your circumstances change,” Bruce and Frederick write. “Although it’s better to start early, if you don’t have a financial plan in place, there is no time like the present.” 

NO COMMENTS