Ways to mine out this financial crisis

Listening to several economists and industry professionals at a recently held mutual fund conference in the region, one finally gets a sense that the industry has started to get its head around the chronology of events and the main reasons that have resulted in the current global economic crisis.

More importantly, the government and regulators seem to have developed a better understanding of the initiatives to be taken to overcome the current situation and have begun acting in a co-ordinated manner that is absolutely essential if we are to recover from this crisis in a timely manner.

However, as I travel through the different countries around the region, the one thing that strikes me is that the "Global Crisis" isn't really as global as it is made out to be. While the equity markets have suffered in virtually all countries, the economic impact for investors has been uneven depending on local conditions.

Also, local regulations and differing practices in wealth management have ensured that the individual investor hasn't met the same fate in all jurisdictions. To my mind the two key factors that have resulted in the difference between various countries is the quality of financial planning provided to individual investors and their ability to leverage their investments or get access to easy credit.

Good quality financial planning ensures that retail investors have diversified portfolios that reflect their level of risk appetite. Such portfolios have simple and time tested products that are well understood by retail investors. On the other hand in less developed markets where wealth management is a relatively new concept, the focus is more on product selling rather than asset allocation and diversification.

Ironically, such jurisdictions are also more lenient in allowing relatively new and complex products such as hedge funds and structured notes to be sold to retail investors who may not appreciate the costs of such instruments and the level of risk they are being exposed to. The results are there for everyone to see: investors who have received good quality advice may be down about 20-30 per cent, whereas investors exposed to riskier asset classes may have lost as much as 70 per cent or more of their portfolio value.

The effects of the ability to invest by borrowing or invest in products that are highly leveraged internally have been even more devastating for the consumers. Not only has the value of their investments taken a beating, they are facing margin calls as well. This has resulted in clients having to liquidate their good quality assets (which brings down the markets further) in order to satisfy the margin requirements for their underperforming assets or even worse — having to default on their obligations.

In my opinion, this is the one key factor that differentiates the fate of individual investors in such market conditions.

Unlike the leveraged individuals, those investors who have placed their money in the financial markets, while no doubt being hurt financially in the downturn, will be able to come out of the present situation because of their ability to wait for the cycle to turn.

Regulation has a very important role to play in ensuring that individual investors are adequately protected.

Jurisdictions regulate the products that can or cannot be sold to retail clients, ensure that financial products are only sold by well qualified advisors and provides the framework that the banking system can only provide credit in a prudent manner have significantly reduced the extent of hurt felt by their citizens. The reverse is obviously true for jurisdictions that aren't as well regulated.

Way forward

So what is the way forward for clients that have been impacted by this crisis? Frankly, there is little one can do except going back to the basics. Firstly, they need to remember, what I guess is a cliché for some: it is the time in the market and not the timing that is more important. A lot of investors have been tempted to redeem their investments and convert their notional losses into a real one. This may be unwise especially given the magnitude of the losses suffered. Investing in a high yielding fixed deposit is not a suitable choice as it will take much longer to recover your capital than waiting for a market recovery (unless this is really the end of the world as we know it). Therefore, investors have little choice but to keep invested and wait for the cycle to turn — which it will eventually in due course. Timing the markets is very difficult and those who exit may find it difficult to re-enter at the right time and will most likely lose out on much of the upside potential.

On the other hand, I would also like to caution those people who feel that the current valuations are great and anything that they buy at these prices will result in "supernatural" returns in a relatively short period of time. This may well be true, but only for those investors who have the necessary risk appetite, staying power and patience.

Naive investors may find that markets can fall much further and that the recovery can take much longer than they currently anticipate. While the cycle will turn for sure, the timing of the recovery is anybody's guess. For those who are brave enough to venture out at these times, I would recommend a good regular savings plan that will help them average out their purchase price in case markets fall further. I would even encourage those that have the liquidity and the ability to invest for the long term to take advantage of the current low prices and enter the markets in this measured manner.

Finally, while I think it is impossible to be absolutely certain as to when the markets will recover, it is certainly extremely important for all the market players – issuers, product providers, financial intermediaries, investors and most importantly regulators and policy makers — to learn from the current situation and take the necessary steps to ensure that we only read about such crisis in history books.

The writer is a senior director at Franklin Templeton Investments. The views expressed in the article are his personal opinions.