01/07/2010 - 00:00

Investors must adapt to the ‘new normal’

01/07/2010 - 00:00


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There is a ‘new normal’ that besets the global economy, challenging the traditional approach to wealth creation and affecting us all.

THERE are very few board meetings that start with a prayer and end up shaking the world’s financial system.

Then again, there are even fewer financial institutions controlled by Fr Santiago Gomez Sierra, whose expertise is more in philosophy than finance.

Fr Sierra is a Spanish priest who became well known in financial markets as the man who shook the euro this year and, in the shockwaves that followed, caused the markdown of bank stocks around the globe.

As chairman of CajaSur – the small, Catholic Church-owned bank that reportedly lost $880 million last year – his caja, one of many mutually owned banks that ran rampant with money over the boom years and ended up holding about half of Spain’s loans, was the first to fall.

Spanish authorities are now trying to buttress the weakest of them, already having taken over CajaSur.

So, as we ponder whether PIGS can fly – meaning, there are big doubts as to whether Portugal, Italy, Greece and Spain are financially sound – here we have a humble priest right up there with the high falutin’ financial engineers responsible for dawning the ‘new normal’ upon us.

PIMCO co-chief investment officer Bill Gross coined the term ‘new normal’ last year. PIMCO is one of the world’s biggest money managers, with about a trillion dollars under management. The term defines the future as slow-growing economies, static profits, and significant government intervention and regulation.

The punchline, according to The Economist, is that “the consumer stops shopping until he drops and starts saving to the grave”. If that’s the future, all of us have something to worry about if we intend seeing out our years in relative comfort.

And that’s the question before the jury – are we, indeed, in a new normal?

My case today is that we are. Like it or not, 2008 marked the demise of the ‘great age’ of private leverage, asset and credit-based entitlements, self regulation and shrinking government characterised by offering policy moderation.

Privatised gains of the post-war era became socialised losses when the music stopped.

The heavy hand of government has re-emerged as a viable alternative to the invisible hand of capitalism.

We are at a moment of generational change. What happened in 2008 was not simply a ‘significant event’ – it was more than just a cyclical flesh wound, as Mr Gross’s partner Mohamed El-Erian (a former economist and deputy director of the International Monetary Fund) describes it.

We have entered the new normal economy, a world very different from the recent course we set. Increasing government balance sheets, increasing regulation and compliance complexity, de-globalisation and protectionist sentiment, are elements of our new normal.

Economic implications are increasing sovereign risk, subdued growth, relatively higher levels of unemployment, less global market cohesion, and the prospect of inflationary pressures as governments withdraw stimulus, leaving a re-regulated, risk-emancipated banking system to replace its credit creation role.

Is it any wonder capital flows have been volatile? Well, get used to it.

As Mr El-Erian told Forbes Magazine earlier this year: “When the US and global economy reset after the crisis, (the global economy) will look different. This has implications for investment strategies. You have to be able to actively manage risk.”

The use of historical models based on the past 50 years or so for econometric forecasting is useless, even counter-productive.

Mainstream cookie cutter asset allocation solutions used by our superannuation funds and many of Australia’s wealth management organisations also fail to face the reality of the new normal economy and its implications for wealth creation.

Trustees and other purveyors of wealth management advice will no longer be able to rely on the historically profitable ‘buy and hold’ (aka hope) philosophy. Investors are already challenging it.

That’s why self-managed superannuation funds are the fastest growing segment in the industry, while index funds compete and often outperform most actively managed funds. Managing money this traditional way is becoming a commoditised business that most investors can do themselves and, hence, most have an opinion on how best to do it.

Buy-and-hold investors in Japan have not made money in stocks over the past 25 years; U.S investors have been losing money for 12 years; in the UK, 13 years; Germany, similar.

It’s been almost three years since Australian buy and hold investors have made money.

Get my drift? Falling stock prices have actually been with us for some time. So where to now in a low interest rate environment where you have to take some risk if you want to retire before ingesting food through a straw?

The answer is alpha. Skill-based solution providers are out there, and a number have been beating the indices and making decent returns over the past few years.

Investment strategies like long-short equity, market neutral, global macro, commodity trading, event driven and volatility arbitrage will be part of the new normal lexicon – at least for those looking to the horizon, not the rear vision mirror.

As Mr El-Erian wrote recently in the IMF’s Finance & Development Magazine: “Given the scale of ongoing and prospective changes in the global economy, the alternative of backward-looking business as usual would be even riskier” (than ignoring active, alternative wealth funds).

A dwindling number of observers and players in the markets believe the next 30 years will be like the past 30 and that things will comfortably ‘bounce back’.

And that is the central tenet of the new normal philosophy.

 Jon Horton is managing partner of Perth-based hedge funds company NWQ Capital Management, which manages the NWQ Diversified Fund.


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