The possibility of a calamity ranging from economic collapse to civil unrest or even a major war is becoming difficult to ignore.
Looting in London is still fresh in the mind, and last week a Chinese warship confronted an Indian naval vessel in the South China Sea in July. the Western economies, meanwhile, are fragile.
Investors who want to protect themselves from apocalypse have two options: they can try to construct their portfolios so that they are robust enough to withstand most major disasters, or they can try to watch out for impending crises, ready to move into safe assets at the first hint of trouble.
Tim Hodgson, a senior investment consultant at Towers Watson, said: “I think most investors should choose the first, and hold a robust portfolio. But most will attempt to do the second. That’s because a robust portfolio will look as if it’s underachieving.”
Investors in search of safety have typically put their money into cash, especially Swiss francs, US dollars, Japanese yen and gold.
This gives them the option of buying assets in the wake of a disaster, when the prices are at rock bottom, although they may have to wait a long time for a recovery – those who acquired bombed-out land after World War II made fortunes, but only in the 1970s.
They might hold a few equities, some bonds, farmland and maybe some volatility derivatives, but their portfolio will be heavy with cash. herein lies the problem, especially for pension schemes, which have to generate investment returns to meet their liabilities.
Cash has a negative real yield. the Swiss franc is expensive, and dollars and yen look precarious. And even if they were hoarding cash, it might not protect them, because different shocks have different effects.
In a paper Towers Watson published in 2009, “Extreme Risks”, the firm found no general hedge against climate change, and no obvious hedge against a rise of extremist groups. this is why institutional investors hold on to risky portfolios and cling to the hope that they’ll be able to spot a disaster before it hits.
Relying on advance warnings is fraught with difficulty. Investors have to make sure they can sell their assets in time. Some signals turn out to be false and if everyone hears the same warning bell, they will all rush to the exit at the same time. there will be winners and losers, and the loser may be you.
But Andrew Milligan, head of global strategy at Standard Life Investments, is more sanguine. He said: “There are millions of retail and thousands of institutional investors, so you may still have a relative advantage: you may be third in the queue for gold, but it’s better than being last.”
Indeed, being third in the queue may be good enough for some investors – for example, an endowment or a pension scheme with a vast surplus, or a high net worth individual investing assets he or she can afford to lose.
Range of views
Johanna Kyrklund, head of the multi-asset team at Schroders, views the probability of an event such as a large-scale war or the collapse of the Western financial system as 1% at most, and so she isn’t protecting her portfolio.
She says: “I always believe that portfolios should have someone at the tiller to deal with unforeseen circumstances, and hopefully pre-empt some of them. you can see events coming to some extent, [so] you typically have a few months to work it out, but you need the flexibility to adjust your portfolio.”
Kyrklund says she listens to experts on all sorts of issues with the express purpose of learning how to decipher signals. she adds: “It’s not for trading, it’s information that needs to be at the back of my mind.”
She’s found no general way of assessing political risk, whose nature varies with circumstances, but keeps an eye on financial measures such as the spread between emerging market debt and US Treasuries, or the volatility in the euro/Swiss franc exchange rate.
Schroders uses Williams Inference, a US research company, to analyse low-level, long-term trends. If a crisis was looming, Kyrklund might go into gold, or buy inflation hedging or look at currency, but it has to be at the right price.
She said: “Gold is often cited as a safe asset, but even gold might not be any good if it’s too expensive. so it’s all about being flexible.”
Nick Bullman, managing partner of CheckRisk, which analyses risks for investors, is more concerned. He puts the probability of disaster at 10% or more.
He said: “Risky events tend to cluster. the financial crisis of 2008 was a sign that we’re in a cluster of big events and, historically, clusters like this last a decade. Risk can also seem to jump from one part of the system to another.
So we’re in a period of great instability where events can arise unpredictably. Governments have totally underestimated the scale of the problem and the more they dither, the worse it will get.”
Although the threat of a major war is real, Bullman said civil unrest at home is more likely, but this can give rise to political extremism and escalate into a greater conflict further afield.
His team tries to gauge any danger by studying rates of change in more than 150 measures, such as the freight rates shown by the Baltic Dry index and by the new ConTex index.
Two months’ notice
Bullman said: “You get warnings at least three to six months in advance, so if you use a risk system, you should get at least two months’ warning. It’s like seismology: you can’t predict the exact day and location of an earthquake, but you get signs that you can use to anticipate one.”
If trouble appears, he suggests that investors consider buying some carefully selected bonds, food, water and precious metals, including gold.
He said: “I’m not surprised the gold price has risen, and I think it will continue to rise as these uncertainties persist. I bought gold for the first time three years ago, at $780 an ounce; it’s now at over $1,820 and I think it will go to $2,300, its inflation-adjusted record high.
I don’t particularly understand gold, but I know you can’t print more of it, and the Western world is hell-bent on printing money.”
Glyn Jones, chief investment officer at the investment consultancy and asset manager P-Solve, thinks there is a real likelihood of civil strife. He said: “Governments have made promises that they cannot keep, because they’re based on economic growth that will not happen.”
He aims to anticipate events, but he puts the probability of disaster at 25% and three weeks ago, in response to current instability, he put some of his fund’s money into gold.
It was the first time he had invested in it, despite its price being pushed up by investors using exchange-traded funds: “As an investment, gold is difficult to understand, because it has little practical use. It’s a psychological thing: gold has value because people believe it has value.”
He is avoiding all continental European assets. He has nothing in private equity or infrastructure, which he says don’t reward investors for tying up their money. He isn’t keen on commercial property because he thinks it won’t protect investors against inflation in the current, low-growth environment.
He likes timber, but is cautious about the possibility of disease damaging the assets. He’s interested in resources, but prefers energy to water or agricultural land because energy is more portable.
The only area he likes is the infrastructure supporting technology – not shares in LinkedIn or Facebook, but the towers and cables supporting them.
More pessimistic than Jones is David Murrin, founder of the UK hedge fund manager Emergent. He said: “There is a 75% chance of a major conflict at any time from 2017. It’s inevitable, the only question is the date.”
Where to go
Murrin is avoiding assets in China because it’s a growing empire, which has never allowed foreigners to benefit from its expansion. He is cautious about India, where he says the businessmen are probably sharper than Western investors.
Africa, however, is the best place to invest, he believes. He said: “The story of it being a basket case is past its sell-by date. We’re investing in Africa in agricultural land, mining, hydrocarbons and infrastructure growth.”
He urges caution in deciding which currency to invest in; he is avoiding US dollars and euros, but likes the renminbi, which he says is the currency of the future.
His view of the renminbi is shared by HSBC, which says it is poised to become the world’s reserve currency in the 21st century. Murrin is another investor who likes gold. He said: “The price of gold will keep going up; it is a stable currency in a world where paper money is losing its value.”
But gold won’t be the answer to every disaster, fund managers say. an epidemic of a new form of bird flu, for example, could bring trade crunching to a halt, and gold wouldn’t help – unlike owning shares in a pharmaceutical company, which would be a great investment.
The greater the disaster, the more difficult it would be to find any form of protection. Wars wipe out stock exchanges. Property is razed to the ground. Land is expropriated.
In the face of an extreme scenario, one fund manager recommended Jim Slater’s tip of 1975: people should invest in “an ample supply of tins of baked beans, a bicycle, krugerrands and a shotgun”, while another fund manager said: “Gold is very heavy to transport, I like diamonds; they’re valuable, and they’re portable”. But none of this advice is of much use to an institutional investor.
Andrew Kirton, chief investment officer at investment consultant Mercer, said the combination of a truly global war, pestilence and famine would all but wipe out all assets, if only due to a shortage of buyers.
He said: “I am inclined to the view that one shouldn’t waste time trying to think what investment strategies would be of any use in a worldwide conflagration.”
<a href="http://www.efinancialnews.com/story/2011-09-05/dodging-the-bullets-as-the-balloon-goes-up?mod=sectionheadlines-IB-AMtag:news.google.com,2005:cluster=http://www.efinancialnews.com/story/2011-09-05/dodging-the-bullets-as-the-balloon-goes-up?mod=sectionheadlines-IB-AMSun, 04 Sep 2011 23:03:46 GMT 00:00″>Dodging the bullets as the balloon goes up