On Target Newsletter

In this issue:

  • Fund manager selection
  • Dealing with bear markets
  • China’s property crisis
  • Indonesia

Investment Risk in Fund Manager Selection

Entrusting your capital to even the best-known and most prestigious of investment advisers can be a gamble.

Financial advisers often speak and write about the various kinds of risks that investors face – that markets may fall or the issuer of a security may go bankrupt. But I have never seen any of them refer to one of the biggest perils facing the individual investor – fund manager risk.

I’m sure most of us have had the experience that the moment we invest in a fund on the basis of the manager’s excellent record, the fund starts to underperform… or even nosedive.

There are many reasons for this:

► Outperformance often arises because a fund happens to be in the right place at the right time. It may be focused on Asia when things there are going particularly well, in blue chips when the weight of institutional money is pouring into large-cap stocks, or in a currently fashionable sector such as infotech. When fundamentals change or market sentiment turns, the fund loses its temporary advantage.

► This wouldn’t matter where the fund shifts its capital out of underperforming sectors or asset classes into those that have started to run. But this is rarely possible because of structural constraints. An Asian fund can’t switch its money to America, or an equity fund into bonds.

► There are also human constraints. Portfolio managers, for example, are prejudiced in favour of the kinds of investments with which they are familiar. A manager who is well-informed about tech stocks resists a switch to defensive stocks such as equity income when fundamentals change in favour of them.

► Another source of outperformance is the talent of an individual manager. But investment stars are readily poached by competitors or lured into hedge fund boutiques. When they leave, they are rarely replaced by people of equivalent talent. So the fund’s performance slips. Funds that have been top performers nearly always revert to being average, or worse, after a few years of delivering sizzling returns.

► Institutional managers are risk-averse, even risk-avoidance-obsessed, to avoid the criticism of clients, bosses, peers and now regulators whenever there are capital losses. Lower returns are an inevitable consequence.

► Fund managers work within corporate structures that reward conformity rather than minority views. Career-wise, it’s safer to go along with group-think that you’re uncomfortable with than to fight for your own minority, perhaps solitary, opinion. But consensus decisions usually deliver average returns.

► It’s much easier with your clients, colleagues and bosses to invest in shares that are currently rising, even though there’s much academic evidence that over longer time-spans it’s neglected stocks that are likely to outperform.

► Absence of a rigorous selling discipline. One reason is that it’s often difficult for a major fund holding a lot of a share to sell out without driving down the price against itself. Another is that fund managers have a bias towards optimism. It’s very important for them that markets should rise, which attracts investors’ capital and boosts the management company’s profits. So “the wish becomes father to the thought”. Buy recommendations have nearly always outnumbered sell recommendations by huge margins such as ten to one.

There are three ways to avoid fund manager risk:

Use index-tracking funds. They require no decisions about which shares to invest in or when to do so, so you are not exposed to the risk of manager misjudgements. A Vanguard study suggested that 93 per cent of the time you’ll do better in them than taking the chance on using active managers.

They’re much cheaper, too, as you’re not paying fat fees for underperformance. This cost-saving alone can make a significant difference to your eventual returns, especially now we have entered an era of single-digit returns.

Achieving guaranteed low-risk returns

Use a rebalancing plan. You allocate your capital according to a rigid formula – such as 25 per cent each in equities, bonds, property and gold. At the end of each year you rebalance your portfolio by selling and buying securities, or perhaps just redirecting the flow of new savings, to bring the proportions back to 25 per cent each.

This guarantees you modest but low-risk returns. You don’t have to make any investment decisions, with minimal hassle and low costs.

Do-it-yourself. Actively managing your own wealth is higher-risk, especially in the earlier years when you’re building up experience, but it should ultimately deliver bigger returns.

Although it’s true that, as an individual investor, you lack advantages of a professional manager such as access to corporate managements, analytical expertise and databases, you have some counterbalancing advantages:

► As it’s your money, you’ll remain intensely focused. You can monitor your affairs much more closely – on a daily basis if needs be. No professional manager can afford the time to do that for you with similar intensity.

► As you only deal in tiny volumes compared to fund managers, you are able quickly to jump into or out of markets, and invest in growing companies whose stock is too narrowly traded to interest financial institutions. You can make decisions based on factual analysis, without having to take into account company policy, peer group influences, or the views of sluggish, consensus-seeking committees.

► You save on the usually substantial overt and hidden charges you pay for someone else to manage your money. Of course, the price is many hours of your time. But for most of us who do it, that’s more a pleasure than a burden.

Expat Investors: Dealing with Bear Markets

By Chad & Peggy Creveling

After recent stomach-churning gyrations in the markets, many expat investors may be ready to throw in the towel. And who can blame them? With the possibility of a global economic recession, continued high oil prices, ongoing war, and leadership assassinations and resignations, there seems to be no place to hide. At time of writing, major indices such as the S&P 500 and NASDAQ are off over 18 and 25 per cent respectively this year as measured in US dollars; many of the other markets are even worse off.

In times like these, it’s easy to get spooked into making emotional decisions that can derail your financial future. As always, the best course is a calm, rational approach. Here are a few steps you can take now to help you take an objective look at your portfolios, limit the damage, and help protect your financial security…

Don’t panic. The “losses” aren’t permanent unless you make them so. Fear-based selling just locks in losses, triggers taxable capital gains, and increases the chance you will miss out the next leg up of the market. Giving in to short-term emotional decision-making is the reason most individual investors fail to achieve their investment goals.

Review your emergency funds. Ensure you have three to six months (more in some cases) of living expenses set aside in a cash account to fund unexpected events such as a job loss or illness. The funds should be liquid, risk-free, and in the currency you will probably need them in. For example, if you live in Thailand and have no connection to Australia, the Oz dollar is not the place for your emergency funds.

Review your short-term goals and their funding. Take a look at your financial objectives over the next three to five years. Set aside funds for these in low-risk, liquid investments in the currencies that will be needed. These funds do not belong in shares. In fact it may make sense to hold them in an account separate from your long-term portfolio to help you manage the different asset allocations, time horizons and risks associated with your various financial goals.

Make sure you’re diversified. The point of diversification is to reduce the risk of catastrophic loss by not having all your funds in one investment. It doesn’t mean you will never experience a market downturn or a loss. You should be in a broad range of both fixed income and equity asset classes held in a mix that is appropriate for the amount of risk/volatility you can accept in your portfolio.

Reassess your risk tolerance. If you’ve ever worked with a financial adviser, you’ve no doubt filled out some version of a risk tolerance questionnaire. The point of such a questionnaire is to help in the construction of a portfolio that matches your willingness and ability to bear risk in your investment portfolio. It’s one thing to say you’re willing to bear a 20 per cent markdown in your portfolio’s value during the space of a tough year in the pursuit of longer-term investment turns; it may be an entirely different thing when your portfolio is actually down 20 per cent.

This is a good time to get a read on your real risk tolerance. Determine the short-term loss you were able to bear before becoming extremely uncomfortable. That is probably a closer estimation of your risk tolerance than any questionnaire can provide.

If the current market downturn has already exceeded your comfort zone, you may need to redo your portfolio. It’s better to have a more conservative portfolio that you can stick with throughout the markets’ ups and downs rather than a more aggressive portfolio you are forced to abandon when the going gets rough.

Don’t be seduced by apparent “safe havens.” Be wary of assets such as gold, Bitcoin, or any asset that has become a home for investors fleeing risk. Investments like these rise not because of any intrinsic economic return afforded investors, such as that provided by stocks and bonds, but simply because more people are buying them… fleeing risk or speculating. Anything backed by little more than pyramid buying can collapse just as quickly. You don’t want to be the one left holding the bag.

Continue to re-balance or contribute to your portfolio. In times like these it may be tempting to stop contributing to your portfolio or avoid re-balancing back into asset classes that have been going down in value. This is where gains are made. If you wait until everything feels rosy, all you are doing is buying in at the peaks, which will significantly reduce your long-run portfolio return.

You can’t time the market, but by consistently contributing to your portfolio and/or moving to your core investment weightings, you can ensure that you will put more money to work when prices are low. This will help set you up for better investment returns.

Investors who will come out ahead, in the long run, are the ones who can avoid being panicked into the destructive cycle of buying high and selling low. Do yourself a favour and turn off the news. Make sure your short-term goals are funded appropriately and then do something relaxing. Later, come back and take a calm, objective look at your portfolio.

The Crevelings are Thailand-based CFAs who advise expats on personal financial planning. To learn more, visit their website: www.crevelingandcreveling.com.

The Agony of China’s Property Crisis

China’s economic output will lag behind the rest of Asia for the first time this year since 1990, according to World Bank forecasts that highlight the damage done by President Xi Jinping’s zero-Covid policies, and the meltdown of the world’s biggest property market.

The bank now expects the economy to grow only 2.8 per cent compared to 8.1 per cent last year.

Although Beijing set a GNP target of 5½ per cent for this year, the outlook has deteriorated markedly over the past six months. Xi’s policy of relentlessly suppressing coronavirus outbreaks through snap lockdowns and mass testing has sapped consumer activity.

The crisis in residential property triggered by Xi’s aggressive clampdown on speculation is huge, and worsening. In July new project starts were down 45 per cent year-on-year, sales of new homes were down 29 per cent and property investment by 12 per cent.

For decades the property industry has been symbolic of China’s rise to superpower. Private entrepreneurs have made vast fortunes. Average people witnessed their net worth soar as home values trebled. An astonishing 70 per cent of Chinese household wealth is invested in real estate. Local governments filled their coffers selling vast tracts of land to developers.

Two years ago the government decided to tackle the problem of the enormous speculative bubble in residential property. Xi said “housing is for living in – not for speculation.” The government introduced the “three red lines” programme to impose limits on borrowing by developers. It restricted their ratios of liabilities to assets, net debt to equity and cash to short-term debt.

The plan was to slow house building to a sensible pace, but it exposed the reality that debt has been taken to extremes. Slowdown turned into collapse. The programme deprived property firms of the cash they needed to finish building flats they sold in advance. Last year developers pre-sold 90 per cent of homes. And it deprived local governments of revenue from sales of land they own, which have been providing the councils with about 40 per cent of their income.

Investors have been shocked by developers’ failure to complete the projects in which they had invested. These delays made it harder for developers to sell units in new projects. In parts of the country, distress has turned into defiance. Mortgage holders have banded together to stop repaying their loans if work does not resume on long-overdue partially-completed projects. Millions are waiting, often for years, to be able to occupy homes for which they have paid. Only 60 per cent of homes that were pre-sold between 2013 and 2020 have been delivered.

Measures taken to ease the distress

Beijing hasn’t halted its red lines clampdown, but it has introduced measures to ease the distress. The government, overwhelmed by the complexity of the crisis. has been trying quick fixes. It has cut interest rates and allowed local governments to ease restrictions on who can own property, and how. It has also encouraged local bail-outs of unfinished construction projects. But local authorities lack the resources to ease the distress because property downturns deprive them of revenues from land sales,

Country Garden, the biggest developer by sales, has reported that its profits have collapsed… almost disappeared… and says the market “has slid rapidly into severe depression. The entire industry is at risk.”

The property crisis, along with zero-Covid and a purge of the domestic tech giants, have been the botches of big issues that Xi has been making. However his failures are unlikely to prevent his capturing at this month’s party conference a third period as president.

The ‘Next Big Opportunity in Asia’

Indonesia has long been considered by some analysts to be “Asia’s next big opportunity” with one of the world’s largest populations, young demographics, a rapidly-expanding middle class and abundant natural resources, yet it hasn’t lived up to its potential because of poor infrastructure, a complex regulatory environment, and governance unwelcoming to foreign investment.

That seems to be changing.

When leaders of the G20 group, the co-ordinating forum of most of the world’s largest economies, meet in Indonesia next month, they will see a nation starting to deliver on its promise.

“At a time when the global economy is being battered by the war in Ukraine and the energy, food and climate crises, Indonesia has emerged as an unlikely outlier,” the FT reports, “boasting both a booming economy and period of political stability.”

Its economy is growing at an annual rate of more than 5 per cent, inflation is only half that being experienced in Europe and America, its currency is among the best-performing in Asia, exports are up 30 per cent year-on-year and its stock market is hitting record highs. As a major producer of nickel, coal, palm oil and other commodities, the country is a beneficiary of the global boom in natural resources.

Under the leadership of President Joko Widodo, governance has been transformed. He pushed through a series of badly-needed structural reforms hampering economic growth, modernizing labour laws, simplifying licensing procedures and improving the ease of doing business.

He instituted the biggest infrastructure programme in the nation’s history. In eight years his governments have built more than 2,000 kilometres of toll roads, 16 airports, 18 ports and 38 dams.

He plans to use the G20 event, which he will be chairing, to court the interest of global investors in his most ambitious and controversial plan – to shift the nation’s capital from Jakarta, the megalopolis that is sinking by up to 25 cms a year, to the jungle-clad island of Borneo. The new city of Nusantara will eventually be four times the size of Jakarta. The first phase of the project, which entails moving the presidential palace, the headquarters of the armed forces, the police and other ministries, is planned for 2024.

One of the reasons Widodo has been so successful and popular is his flexibility in securing the collaboration of opposing politicians. One example is the way he dealt with the problem of Prabowo Sumianto Djojohadikusomo, a former army general who ran a fierce campaign against him in 2018, by taking him into the government as defence minister.

His job creation legal reforms are encouraging international companies, especially those seeking to diversify from dependence on producing in China, to open plants in Indonesia. Although still focused on commodities, its export industries now encompass manufactures such as textiles, garments, footwear, machinery, furniture, electronics, automobiles.

In 2020 the government banned the export of nickel ore, forcing companies to begin refining it in the country. Its reserves of the metal are, with Australia, the world’s largest. Although most of the end-product goes into making stainless steel, the aim is to produce more of the higher-grade material used in batteries for electric vehicles.

The Benefits of Trend-following Funds

Price Value Partners allocate about a fifth of their clients’ portfolios to trend-following funds. These make no attempt to predict the future. Instead they try to ride strong price trends wherever they’re happening: in shares, currencies, commodities, interest rates.

If a trend-following manager can’t identify a strong trend – whether up or down is largely irrelevant – he/she simply stays in cash or equivalents such as Treasury bills.

They don’t have a market view, but follow their own pre-set rules. One might be, when a given asset reaches a new 52-week high, then buy it. Similarly, when an asset reaches a new 52-week low, sell it.

They use a variety of risk controls to ensure that they’re not easily bounced into heavily loss-making trades. If they have the discipline to follow through on their basic strategy, they tend to deliver two things to their investors:

► Whatever their returns, they’ll be in a form that is uncorrelated to the behaviour of markets generally. This is intuitive to the extent that at any one time, they may have no positions in the markets. If they do, they are as likely to be short as they are long in a diversified portfolio,

► When financial markets undergo a serious correction, trend-followers tend to make significant returns. This is also intuitive, to the extent that when multiple markets head south, trend-followers simply short those markets for as long as the downward price trend lasts. This gives them a key advantage over conventional fund managers, who during bear markets can do little other than shelter in cash. Conventional long-only fund managers cannot benefit from bear markets but trend-following managers can.

Emerging Markets: Expect Recovery Will Take Long

Before the global financial crisis of 2007/9, profit margins for emerging and developed markets were similar, but after the crisis American profits bounced back, those in the Third World didn’t. Net profits expected by analysts this year and the next sit at 7.5 per cent in emerging markets, compared with 12.8 per cent in America and 8.9 per cent in the Eurozone.

Several factors explain this.

Commodities are a major contributor to emerging-market profits, but commodity prices are no longer sky-high. Many of the companies in emerging economies are state-owned; politicians lumber their profitability with social responsibilities. Chinese stocks account for a third, but their profits have been depressed by over-production. The rise of firms with large stocks of intangible assets, such as software and intellectual property, explains much of the increase in profits in the rich world. Developing economies spend far less on research and development. According to the World Bank, R&D investment runs at less than 1 per cent of GDP in India, Indonesia, Mexico and South Africa.

For these reasons it’s likely to be a long time before the performance of emerging-market stocks match those available in the rich world.

The Costs of Virtue-Signalling

In America Republicans are forcing Democrats to pay for their beliefs.

The Biden government has made it easier for undocumented migrants to flood into the country. The number crossing the border with Mexico has hit a record high this year – 2.15 million, up 24 per cent.

Border states are furious at the burden on them imposed by the inflow. They are hitting back by shipping thousands of asylum seekers to northern states run by the Democrats such as New York and Illinois, which operate policies friendly towards illegal refugees such as “sanctuary” cities, which refuse to implement laws that discourage them.

States governed by Democrats are angry at being forced to deliver on their beliefs. New York city mayor Eric Adams has declared a state of emergency to address a “crisis situation” over arrival of busloads of migrants sent from Republican states such as Texas, Florida and Arizona. One in five people in the city shelter system is now an asylum seeker and the influx is on track to cost New York a billion dollars this fiscal year.

The Strong Dollar Is Bad News

A surging currency creates good headlines for Americans looking to travel or send money abroad, but for US companies that generate a big chunk of their earnings overseas, the greenback’s gain has become a serious pain, the FT says.

The US dollar index, which tracks the buck against six other important currencies, is at a near 20-year high. It is up 19 per cent since the start of the year and continues rising.

American companies derive about 30 per cent of their sales outside the US. For techs, the number hits over 50 per cent. A strong buck not only makes their goods more expensive overseas, but revenues earned abroad get squeezed when converted back into dollars.

Morgan Stanley reckons that every one percentage change in the dollar index knocks half a percentage off company profits.


Don’t upset the mandarins: The Swiss banking giant UBS is hiring a team of “content reviewers” to ensure that Chinese research publications by its analysts are free from “sensitivities” in a move that has been criticized as self-censorship. The recruitment drive comes three years after the bank’s top economist was suspended in a dispute over comments he made about an outbreak of swine fever in China that was accused of being a racist slur.

Liquified natural gas: Recent reports suggest that Germany has not been able to agree a contract with Qatar, one of the world’s biggest suppliers of LNG, because Germany doesn’t want to agree a long-term contract of at least 20 years. This is the basis on which Qatar normally agrees. The German government’s obsession with renewable energy means that it’s unattractive as a partner for gas contracts.

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