September 15: Mark That Day With A Big Black Box On Your Calendar

Sydney Morning Herald

Saturday September 20, 2008

ANNETTE SAMPSON

Mark September 15 into your diaries. It's the date the world shifted into full scale financial panic. Not surprising, really. It's not every week that we see the disappearance of two of the investment banking world's giants, Britain's largest mortgage lender, and one of the world's largest insurance companies - and that was just the road toll at deadline late Thursday afternoon. With reports of other institutions teetering, the casualty list is by no means complete.

But the most spine-chilling sight of the week was not former masters of the universe packing up their desks, but the former Federal Reserve chairman, Alan Greenspan, talking of "a once-in-a-half-century, probably once-in-a-century type of event".

From the man blamed for causing many of the problems by cutting interest rates every time the boom showed signs of faltering, there was little comfort for investors.

Some are already hoisting the white flag. The managing director of SuperRatings, Jeff Bresnahan, says super funds are reporting "an across the board" switching of fund members from balanced investment options to cash, though it has not reached worrying levels.

Ian Silk, the chief executive of the $29 billion fund Australian Super, says the level of switching by members has kicked up and "it's all one way, from more aggressive investment options to more conservative ones". But to put that in context, he says, it has been from a low base. "We expected our call centre to be swamped, but [Wednesday] was our highest number of calls and it was still less than we were anticipating."

If anything, says Silk, the bad news on markets hitting the front pages this week has helped to condition members for the arrival of their annual statements which show a loss for the past financial year. "They're less surprised when they see their account."

First State Super's chief executive, Michael Dwyer, similarly says he has seen a "slightly elevated" level of both queries and switching but most members are holding their nerve. He says other fund executives he has spoken to have reported similar trends.

Bresnahan says super funds have been hard hit by the latest falls. Over the past 12 months, the average balanced fund has lost about 12.5 per cent - almost double the 6.39 per cent lost over the 12 months to June 30. But investors need to remember that super is not an investment in its own right, merely a structure through which you hold investment assets. Balanced super funds hold 60 to 70 per cent of their assets in shares, and since its high last November the Australian sharemarket has fallen 32 per cent and financial stocks are down more than 40 per cent. While it has been slow, the sharemarket falls are now in the order of a major crash and it does not look like ending any time soon.

"There's no doubt this is extremely serious," says Select Asset Management's chief investment officer, Dominic McCormick. "It's the most serious market dislocation we've seen for decades."

What we are seeing, says McCormick, is a global "deleveraging" as institutions are being forced by falling asset values to reduce their debt levels. Unfortunately such deleveraging can be a vicious cycle where the weight of selling forces prices down, triggering the need for further asset sales.

For retail investors, it is an environment where it is difficult to make rational investment decisions and even harder to make informed ones. We can follow the standard advice and stay put as most super fund members are doing. But that means holding our nerve during weeks like we have just had.

Alternatively, we can say "to hell with this" and switch to safe investments, but miss out on the incredible opportunities that generally arise when things are at their worst.

"The best time to get in will be at times like now, or when the news is even worse," says McCormick.

The other problem with running for cover is that you will crystallise your losses. As McCormick points out, these are the worst possible times to be making decisions based on recent history.

McCormick says investors who want long-term market exposure need to be finding ways to make their portfolios more robust through both good times and bad, minimising their losses from this deleveraging process and positioning themselves to take advantage of the opportunities that will emerge.

For super investors, if your fund is any good at all, this process will already be under way. Trustees are constantly monitoring the funds' portfolio and making adjustments.

Super funds are not immune from poor investments and some funds are better run than others. But super funds are not directly exposed to many of the problems besetting other financial institutions. They are debt free (they are not allowed to borrow), they are generally well-diversified, and they have a unique advantage that the investment banks would kill for. Thanks to compulsory super they have a guaranteed cashflow. That gives them liquidity - the most valuable commodity going in the current environment - and the flexibility to adapt. For example, Silk says Australian Super has also been able to reduce its weighting to shares and boost its cash holdings without having to sell shares at a loss by directing new contributions to cash.

Liquidity will not prevent future losses, but in this market it is a real advantage.

© 2008 Sydney Morning Herald

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