Recovering your market losses?

Saturday May 2, 2009
Recovering your market losses?
MARKETS
By SHERILYN FOONG


THESE challenging times for investors demand a well-thought out, personalised and well-diversified investment strategy. (Always important to have a good investment philosophy and strategy.)

Hard, tough and painful decisions will have to be made, be it in the cruel form of “amputation, that is cutting steep losses on stock duds, or ploughing in more good money (after bad?) via participation in invested companies’ cash calls. (It can be painful to cut the losses, sell the losers. But it is required surgery.)

However; the hardest decision to make is really regarding your personal risk appetite: should you or can you afford to take on more risk so as to (hopefully) recover some of your market losses in your investment portfolio? (Knowing one's ability and willingness to take risk is important. This has to do with the wealth effect, the house money effect, modest diversification and also knowing asset allocation.)

Do or die?

One needs to look at the current global scenario and form some rational conclusions involving an element of personal judgment calls. (The truth is no one knows the future. Just observe the experts giving opinions on CNBC. There are just as many on either sides of the argument. Decision should be a personal one based on ability to take risk. In particular, knowing the consequences of your decision is more important than the probabilities of the outcomes, which arguably is uncertain.)

From there-on, the decision as to whether or not you can or should take on more risk can be a highly daunting task.

But it cannot be helped because the alternative passive option of doing nothing can be even riskier! (Yes, if the consequences of a further fall in your portfolio can force you to do something silly. This assumes that the portfolio was constituted to be a winner. Of course, sell the losers, let the winners run. No easy solution here. There are errors of omission and commission too. But in this very down market, and for those with longer time frame in their investment, the probable upside gain compared to the downside loss is more likely favourable.)

A good starting point can be from taking a good look at all the stimulus packages announced globally and all that has been and still is being done by central banks the world over to stabilise and stimulate the global financial systems and real economies respectively, where the verdict as to its success and effectiveness is still out there. (Ah, looking at the macroeconomics and then adopt a top-down approach to pick stocks. It is just as profitable and safe to start at the micro level and select individual businesses. This is probably easier for the majority of the investors who may not be economists.)

The encouraging news is that some signs of bottoming out are in sight. Sure, one may prefer to opt for more concrete and sustainable evidence of recovery before taking on more risk. (Averaging down is also safe, ignoring some investors who preached this to be unsafe. This strategy is particularly useful for those who can value stocks. Buying a good quality stock at below the "intrinsic value" (that is, a bargain) ensures a margin of safety for possible loss should the decision turns out to be adversely affected by future events. Moreover, buying low ensures a higher return in the future.)

But such a typical “wait and see first” stance is not without its own risk. Because when that happens, when it’s a sure fire conclusion that the said policies have been accurately effective, the ever-efficient and nimble markets would have priced that in rather quickly such that taking risk at those material levels would prove more costly. (Missing the few best days of the market can also reduce one's potential gains significantly. Another is when the market starts to rally, some investors remain frozen outside the market. There is no easy answer for those who attempt to time the market. Staying invested long term based on a good investing philosophy and strategy is safe.)

The market’s ‘Limbo Rock’

What comes to mind here is the investment nugget blink of an eye move of Citigroup stock from a penny stock to multiple top performer before you can say “I’ll take the risk!”.

On this note, I would like to quote my wise friend Kumar who recently told me, ”Keep your money in Bank Simpanan and watch TV!”. Enough said.

The wealth preservation argument prevails here: suppose the markets fall substantially from here, hence doing nothing now and preserving what is left would turn out to be the best strategy. (Now that this chap is out of the market, when would be the right time for him to get back into the market? In the long run, the stocks give a better return compared to savings in the banks. Timing the market works for some "investors"; however, buying and selling stocks based on price is what guides the value investors. Once again, "The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement." - Benjamin Graham )

Playing God

However, what if the market has indeed bottomed and is in the long, slow but steady progress of recovery?

True, no one has perfect foresight. But it’s important to have a calculated and informed view on investments as opposed to pure speculation or it is no different from casino play.

It is imperative to form a personal view of the market outlook to form the foundation of your investment decisions.

This personal investment decision-making process also incorporates your personal investment objectives which has to be realistic. High returns come with higher risks. (There are quite a few stocks delivering 7% - 8% annual return with little downside risks that investors can buy for the long term in our local market. The harder task is to seek out higher returns without undue unacceptable risks.)

Going through this personal investment thought process is a practical exercise in figuring out your acceptable risk levels. (Yes, an investor should regularly goes through this exercise with the preexisting portfolio. Tracking one's investment and reassessing the individual stocks for returns versus risks is part and parcel of intelligent investing.)

Bear in mind that extremely high levels of fear in the markets often exaggerates the real market risk. (And this is the best time to invest in the market, when the fear is at its highest. One need to be wired or re-wired to take advantage of this.)

The lessons of diversification

Over the last year of unprecedented crunch, investors have been battered by losses across almost all asset classes and thus, are predictably retreating from further investing in a herd-like manner. (Faced with this uncertainty, how should one react? Those with the right philosophy and strategy well thought out and observed strictly will be better guided. Understanding the consequences of risk is paramount.)

The point that has been missed is really, how much would have been lost if there had been no diversification at all? (Start with the asset allocation that is appropriate based on various personal factors, including your risk tolerance. According to Buffett, after diversifying into 6 stocks, the 7th stock is unlikely to give a higher return though the risk may be lower.)

Despite the unfortunate highly positive correlation among almost all asset classes in the current financial crisis, one should only look at the converse situation to conclude that diversification still has its magic.

>Sherilyn Foong, who is attached to a private equity firm, believes that the only thing constant in the market is its inconstancy. So, she maintains that the markets will surprise, as they always do.

http://biz.thestar.com.my/news/story.asp?file=/2009/5/2/business/3819025&sec=business