This month’s roller coaster in equity prices has capped a year of extraordinary volatility and left nervous investors whiplashed. Commentaries abound regarding the perils of equity investing and why it is better to stay in cash as the decline in oil prices foretells a period of below average returns in 2015.
With volatility at highs not seen since 2008, the knee-jerk reaction is to wait until the storm abates. However, the recent episode throws up not only important lessons for individual investors, it also highlights the role of institutional buying patterns as the role of capital markets moves into the forefront of the economy.
For confidence in the markets to increase in the longer term (thereby providing for capital formation and a repository for savings), institutional buying by market participants such as pension funds and insurance companies need to be in place. This, in turn, implies that risk-taking appetites in these institutions need to be harnessed to the point where domestic equity risk exposure is a viable alternative to other asset classes.
Capital formation forms the cornerstone of equity markets in any country, providing the most efficient signal for long-term growth of a listed company. It is a platform that provides the most effective way to harness domestic savings. Pension funds and insurance companies in most developed economies play a critical role for small investors to build on savings that capture the growth potential of the economy. They also serve as the best long-term hedge against inflation.
However, these institutional spigots also serve as stabilising forces to smooth volatility, acting as counter-cyclical forces in times of extreme swings in the market. In the UAE, pension funds thus far have been at the periphery and a swathe of mutual funds in the private sector have catered to individual investors (Emirates Bank was the pioneer for domestic equity funds back in 1997).
However, these funds have gravitated to the high-net-worth investors leaving the middle-class out of the equation for the most part. This has had two consequences: it has allowed speculative activity and margin-based investing to dominate in times of exogenous shocks such as the one we recently witnessed, exaggerating price swings. And, it has left the small investor disillusioned with such price shocks, making them either reluctant or unable to capitalise on the long-term fundamentals of the economy.
This, in turn, has hindered the ability of the capital markets to play the critical role that it plays in other developed and emerging economies by creating savings pools that allows for such long-term capital formation.
It is apparent that the UAE’s capital markets are in the beginning stages of “securitisation”. Emirates Reit, Dubai’s malls, and some greenfield initial public offerings have allowed investors to construct a portfolio that offers a balance of stable annuity yield plays as well as high growth opportunities.
However, for the small investor, a channel is still needed to allow for diversification and stable asset allocation that cushions volatility. It is only at the pension fund and similar institutional levels that such a role can be played.
Excitement in the markets is the enemy of investing. Eventually market fundamentals will reassert themselves. The growth rates for the underlying companies in the UAE remain robust for the most part, and with the economy continuing to pick up steam, it is likely that returns will be in the double-digits in 2015.
Investors (individual and institutional alike) will be well served to use dips in the market as buying opportunities with a view to long-term savings as part of their asset allocation strategy. The UAE economy continues to mature with a stable growth platform.
Exogenous shocks will always be a hazard in terms of headline-grabbing news. The anxiety that it creates in the investor psyche will need to be continuously battled if rewards are to be reaped.
The writer is Managing Director at Global Capital Partners.