26th November 2008
Cash is king as freeze hits
Following on from last week's Investment News we once again discuss the appropriateness of cash investments. There has been much written in the press in relation to cash and the need for it to be flowing through the economy again if things are to improve, both for the economy and investors alike.
There are varying opinions on cash and cash investments from market experts. However, recent articles in The Age and Sydney Morning Herald on 19 November 2008, go a long way to explaining the freezing of investors funds, liquidity issues and possible opportunities in the current market.
After the Federal Government's announcement to guarantee bank deposits, it inadvertently triggered a run on mortgage and cash funds. Concerned investors subsequently began redeeming from their non-guaranteed funds and most of the leading mortgage funds were forced to freeze redemptions.
The director for funds services at Standard & Poors (S&P), Peter Ward, commented that "redemption requests couldn't be sustained at that level. Funds had to ensure they didn't have to sell part of their portfolio into a market where they wouldn't achieve the best result".
Phil Clinton, Financial Planner for the Madison Financial Group, commented that "the decision was the correct one for investors even though most may not think so. By freezing redemptions, funds can protect the value of their underlying investments instead of having to flog them at fire-sale prices. Where assets need to be sold, the funds can do so on a more orderly basis. This is fairer to all as under the fire-sale scenario, remaining investors would sustain losses that would not be realized if the investments were held until maturity or sold for a better price." Mr Clinton also commented that "...the freeze shows a 'structural imbalance' with mortgage funds".
Imbalances occur where investors are offered easy access to money that is tied up in long-term investments. Illiquid investments, besides mortgage funds, include direct property, infrastructure, private equity and many fixed-interest investments.
Mortgage funds are not the only funds forced to freeze or change their redemption policies as a result of the crisis. Unlisted property funds, some hedge funds, high-yield funds and an index share fund have run into liquidity problems, but it is mortgage funds that have gained the most attention.
The chief investment officer for Select Asset Management, Dominic McCormick, commented that "this crisis is so severe many retail investment products will not survive". McCormick commented further that "there are a lot of stand-alone investment vehicles that give exposure to illiquid investments that won't be viable on a long-term basis... To some extent that will simplify the industry but it will reduce the opportunities for retail investors."
Peter Ward from S&P said "One of the three mortgage funds it recommends that is still open for business is a
La Trobe fund that locks investors in for 12 months... there are some instances where you can get out earlier but generally you're there for 12 months."
The illiquidity premium
Michael Clancy believes "Illiquidity is not necessarily a bad thing, but if you're going to lock your money away in a long-term investment, you should get a premium for doing so."
Rob Prugue's, Senior Managing Director of Lazard Asset Management Asia Pacific, view on illiquidity is "...A simple test is to look at the spread (or difference in returns) between risk-free and risky assets... When interest rates are low and the economy is robust you see investors take on greater risk for an extra 15 to 20 basis points, but they don't realise they're taking on much greater volatility."
The big picture
Mr McCormick commented that "...Another problem is liquidity is not constant and can vary depending on market conditions... Assets that are reasonably liquid in good times can be very illiquid in difficult times... It's not as simple as saying some assets are liquid and some not. Investors have to recognize that in difficult times even the most liquid assets can become less liquid."
Mr Clancy's view is "The fixed-interest market is a classic case where investments are proving less liquid than might have been expected. Thanks to the US subprime crisis, investors worldwide have lost confidence in debt securities to the extent that central banks have been forced to spend big money buying these securities to try to get markets trading again."
Comments on opportunities by Rob Prugue of Lazard Asset Management and Dominic McCormick of Select Asset Management are as follows:
"While the risks are real, opportunities will also arise. While markets are experiencing liquidity problems, the world is awash with money thanks to lower interest rates and stimulatory measures by governments... Monetary liquidity has never been higher... the question isn't about monetary liquidity but how it is being redistributed in investment. It isn't flowing through into investment assets." - Prague
"Some of the demand for liquidity is rational but we've gone a bit too far... Some of it is just fear. Investors aren't thinking long-term, they just want assets they can get out of tomorrow. The danger with this is they may not be positioning themselves to deal with the next five years and to take advantage of opportunities that will arise. One danger is that when all the pump-priming from central banks and Governments finally hits, investors and Governments will find themselves wrong-footed by rising inflation... People are structuring their portfolios for deflation and illiquidity, but we think there is a real risk, if you look out three years, that inflation will come back with a vengeance... If that happens, investors in cash and term deposits could find themselves losing money in real terms with interest rates lower than inflation."
"Our view is that people should be invested across the liquidity spectrum. One positive is that investors have started getting rewarded again for taking liquidity risk. That wasn't true 12 months ago. We've seen some asset values come off dramatically and in an environment where people are desperate for liquidity, those who can provide it will do well."
Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years - Warren Buffet
Source - The Age and Sydney Morning Herald - 19 November 2008