Investment – How Much is Your Offshore Savings Plan Really Worth?

Life, Work & Investment Abroad

Do you have this type of investment with one of the big life insurance companies? It could be with Generali Worldwide, Friends Provident International, Old Mutual International, RL360, Aviva Global, Zurich International, Investors Trust or Hansard Global it doesn’t really matter which.  How much would you get back if you needed to get access to … Read moreInvestment – How Much is Your Offshore Savings Plan Really Worth?

When it’s best to do nothing!

Losing Hurts More Than Winning

No one likes to lose, in fact losing has a bigger impact on us than winning. Studies on “Loss Aversion” which show that incurring losses may be twice as powerful psychologically as the equivalent gain. From an investment perspective this makes us act in ways which can be contrary to our long term benefit. So lets look at what we do and how we do this.

Taking Our Medicine

When there is a market correction our gut instinct is to get out, sell our positions and move to cash. What does this actually do for us? Nothing! well really it does more than nothing it puts us back with no hope of moving forward. It makes losses real and takes us out of the market excluding us from the inevitable recovery that will come. Markets recover, sometimes this is a quick bounce, other times it can be a long slow protracted recovery.

This is the situation that we seem to struggle with preferring instead the safety of cash. The key here is that markets do recover and our investment in them should be money that we don’t need in the near future. So why not just leave it alone?

The Best Medicine

Actually the best thing that we can do in these situations is to add more money. During these twitchy uncomfortable market maladies when the last thing we feel like doing is investing is when we should.  Adding additional capital when markets are down does a couple of things. Firstly it means markets don’t have to come back to pre-crash levels before we’re back in the black. Second   the losses don’t look as bad thus abating our internal angst. This is one of the reasons that regular contribution investment are so effective for long term savings goals.

Next Best Thing

If making an additional investment isn’t an option then don’t do anything except rebalance your portfolio. Sell what has made money and buy what has lost money. We don’t mean sell everything we hold in the money making assets, only the amount over and above the original allocation percentage. If an asset should make up 5% of our overall portfolio and it has grown over the past year and now makes up 7% of the portfolio, then we sell the additional 2%. Reallocate this surplus to holdings that have fallen below their original allocation rates. This has a similar effect to adding more money into the assets that have fallen in value during market corrections.

As a side note even if you are adding more money into your portfolio when markets fall you should also rebalance your portfolio once a year. This will only enhance your long term performance further.

Everything Is Not The Same

Just because there is an asset in your portfolio that is losing money right now doesn’t mean that you need to sell it. There is a common reaction from investors to want to sell assets that they see as being “underperforming ”. Sometimes this may well be very true (though proper asset selection prevents this), if it is then the asset should be sold. Though more often than not the issue is that the asset is in a down cycle.

So why isn’t this an underperforming asset? Every asset is cyclical whether it be bonds, equities (shares), property or commodities. This cycle can be influenced by external factors such as interest rates, government policy, climatic or conflict. They influence each asset type in different ways and a positive outcome for one may be negative for another.

Too Much Of A Good Thing

If everything in your portfolio does the same thing at the same time, you could make some great returns, well, if you have the balls for it! If you don’t have a strong constitution then you have a problem because you will be in for a rocky ride.

A Bit Of Variety

So if you are of the more conservative persuasion and prefer a smoother ride you are going to need diversity in your portfolio. This will mean that you have assets that do different things at different times. Whilst some holdings are going up in value others will go down and vice versa. The ones that are going down will do the job that you need them to do at some point in the future.

Beware Of Fortune Tellers

I here you say “well why don’t we buy these assets when we need them?” Well the reason for this is that market timing is a mugs game. Even if they know what is going to happen the most advanced predictive modelling systems can’t tell us when it will happen.  Market timers generally buy high and sell low. This is because they get in after an asset has gathered upward momentum and sell as markets are on the way down. Plus how do you know we’re not experiencing a short term consolidation rather than a full blown downturn? The answer to that is, you don’t know and neither does anyone else irrespective of their personal opinions.

This is essentially why we should allocate in this way and accept that not all assets are going to go up in value at the same time. So if you think an asset is underperforming, before you do anything else check what it is doing against its peers and you may find that you have an asset that is outperforming in a downward market which is a very different thing. If it is underperforming then replace it like for like.

The conclusion to all of this is that if you have allocated correctly in the first place. Made investment decisions based on your investment timeframe and good asset selection.  Then market corrections and cycles shouldn’t cause you enormous concern. Put the little voice in it’s place and do nothing.

What is safe?

No Risk Maximum Returns

Investors have an enormous appetite for assets that present them with minimal risk and yet produce the highest possible returns. This is the investment holy grail which many investors believe is possible and many investment providers cater to this belief. The question is does this investment utopia really exist?

 

Can we get 8% per annum returns whilst having a performance chart that looks like a a door wedge? The answer to this is, its just not that simple and whilst on the surface of things there are investments that seem to meet this criteria they do so at a price. That price is liquidity, most investments which produce the types of returns that we crave with a complete lack of volatility come with an enormous amount of liquidity risk.

Liquidity & Why is it important?

So what is liquidity risk and why should we care? Liquidity risk is when it is not possible to dispose of assets quickly enough to meet redemption requests. This means that if you want to withdraw capital from an investment and a number of other people want to do so at the same time then it may not be possible to do so, definitely not when the amount of redemptions exceed the cash available at the time. Liquidity is something that investors take for granted and pay little regard to when considering the risk of an asset however, it becomes extremely important when it is taken away after all, we all want what we can’t have.

If we are talking about funds then the issue is that the underlying assets do not have a a readily available secondary market or it is a very limited market. The reason that we are attracted to these funds is the very reason why we should be wary of them. The steady returns come because there is no easy way to price the assets and this is done using an accounting exercise known as “Mark to Market”. As I am sure you are aware when it comes to accountants there is more than one way to skin a cat and each one comes up with a very different result. Hence the perfect upward trending linear performance chart that we desire so much and all this is great while it lasts, though just wait until assets need to be sold to meet redemptions then the story can and quite often is very different.

 

If the underlying asset is illiquid or there is no immediate way to provide liquidity then assets will need to be sold to what is a limited number of buyers. At this point funds will do a number of different things.

They could suspend trading on the fund (this will be the most common course of action) which means that no-one can by in or sell out of the fund until a sufficient number of assets have been sold to produce the liquidity required to satisfy the redemption requests. This course of action will invariably mean that at some point the fund will be liquidated if the suspension continues for more than 12 months. Investors tend not to like being told that they can’t have their money even if they didn’t want it at the time. Even if the fund does open up again people who hadn’t made redemption requests will now ask for their money back and new investors into the fund will have completely dried up. The issue is when the assets are actually sold the price may not come close to the mark to market price that the fund valuation is based on. This can be a big problem if the fund has a significant amount of debt as it will result in a downward spiral in the fund price as assets are sold. This is because a lower sale price for the assets will be amplified by the borrowing and these losses will be shouldered by the investors rather than the lenders.

Another option that could be applied is a “Market Value Adjuster (MVA) which is essentially an exit charge on the fund this could be a significant percentage of the fund value. This has historically been the domain of with profits funds that have some assets that are more liquid than others. Again if there is borrowing on the fund then this will amplify losses further.

Where is liquidity risk a problem and where it isn’t?

Invariably property funds both commercial, residential and specialist are at risk as they are priced on a mark to market basis, this can mean that the price an asset is given for fund pricing purposes can be dramatically different to the price that someone is prepared to pay for the asset.. When it comes to property, buyers are less common and the sale process is far slower, this is especially true when it comes to commercial or specialist property. The fact that the only way that these funds can meet liquidity is through the sale of assets mean that they will always have these issues when redemptions increase, this is something that we have seen after the Brexit vote with some of the UK’s biggest property funds (7 funds in all with over £18 billion invested) have suspended trading. Interestingly Real Estate Investment Trusts (REIT) are a form of property investment that generate liquidity via the stock market, this means that assets do not have to be sold to meet liquidity. The issue with REITs for many investors is that because the share price can be too volatile because it is determined by the market, yet a REIT will not suspend trading and stop you accessing your capital.

It isn’t just property funds that create an issue anything that is not easily sold yet has to be to meet investors redemptions presents a similar issue. This could be private equity (shares in private companies), traded life insurance policies, mezzanine financing, wine, art, chickens, trees or even football players then these assets will be price on a mark to market basis and will suffer the same issues when investors decide they need capital returned.

The real issue here is our perception of risk, unfortunately volatility is all too often seen as the main measure of risk. Whilst volatility does provide some indication it is a very short term measure, it makes no measure of liquidity risk and makes no consideration of investment timeframe. If we are investing over the longer term (property, equities commodities, corporate bonds & alternative investment should be long term) then we should view risk over this term. People will say “ohhh I don’t invest in shares, that is just too risky for me” and this may be true for short term money, though if you buy an index tracker such as S&P 500 or FTSE All Share how risky is this over the long term. Answer this when was the last time an index went bust? The answer is never, yes we accept that they have had major corrections at times, they have also had major recoveries. plus there are dividends to be reinvested. If we take returns from the S&P500 for the past 30 years we get over 10% per annum (including dividend reinvestment), over 20 years 8% per annum (including dividend reinvestment), over 10 years 7% per annum (including dividend reinvestment), this is with some major stock market crashes. The same people who say that shares are too risky for them will have leveraged commercial property funds in their portfolio, something that is substantially more risky than a major market index tracker yet makes them comfortable because the pricing method eliminates volatility.

So let’s ask the question again. What is safe?