Transcript The stock market isn`t the economy

Some issues concerning international
diversification of investment portfolios
D. W. Stewart, Chief Investment Officer
J.M. Finn & Co.
Salisbury House, London Wall, London EC2M 5TA
Authorised and regulated by FSA, Member of the London Stock Exchange plc.
Journalist: “You’re a legendary film star, and
one of the most handsome men in the world.
With all the temptations that must come your
way, how come you’re still happily married?”
Paul Newman: “Why go out for hamburger,
when you can stay at home and have fillet
steak?”
Sorry, Paul, but sometimes….
…. Hamburgers are good for you!
The stock market isn’t the economy
Romanian Equities: Sector split
Romanian GDP
Agriculture
13%
Industry
28%
Chemicals
3%
Metals &
Mining
5%
Engineering
1% Housebuilding
1%
Pharma
1%
Other
1%
SIF Funds
10%
Services
59%
Source: Economist Intelligence Unit
Banks
22%
Oil
56%
Source: Datastream
I’m correlated to what?
13/10/05
400
350
300
250
200
150
100
50
2003
ROMANIAN EQUITIES
TURKISH EQUITIES
ECUADOREAN GOVT BONDS
2004
2005
COPPER (US$/ tonne)
CANADIAN OIL EXPLORATION COMPANIES
FTSE EUROFIRST 300
Source: DATASTREAM
The need for international
diversification
• The Romanian economy is not reflected in the Romanian
stockmarket
• Longer term, a rise in your portfolios’ liabilities may not be
compensated for by a concomitant rise in the stockmarket.
This is not good news for your clients.
• Shorter term, why care? The Romanian stock market is rising
strongly….
• … but for factors completely beyond the control of Romanian
investors. If it rises for no direct reason, it can just as easily
fall for no reason to do with Romania. You may have no
warnings, and no chance to exit.
• Romanian investors shouldn’t only stay at home. Risk should
be diversified through international investment
My investment approach
• Step 1: Avoid the nightmares
• Step 2: Prudently diversify
amongst the remaining options
The key to diversification
• Effective diversification is NOT about negating or diluting
existing investment decisions
• It IS about finding uncorrelated investment opportunities
• But how to find lack of correlation? Don’t we all live in
one big “global economy”?
• Actually, no…
The myth of the “global economy”
Correlation of main stockmarket with S&P 500
Correlation of Annual
GDP with US
1 year
3 years
1980 - 2000
1980 - 2000
UK
0.81
0.9
0.72
0.6
Eurozone*
0.7
0.9
0.6
0.05
Japan
0.6
0.32
0.37
-0.2
Asia
0.79
0.75
0.28
0.01
* Germany and France for 1980 – 2000 data
Source: SED Inc, BCA Research
Implications & Opportunities
• Economies are uncorrelated, but stock markets are
correlated. Doesn’t this imply that similar economic
exposures are being priced differently around the world?
• Some of these exposures will be uncorrelated to the
elements of one’s existing portfolio
• Thus, an investor might wish to look around the world to
see where are the “cheapest” units of economic growth
determined by factors such as demographic change
Where are the “nightmares”?
• The security of the herd is illusory: crowded spaces are
dangerous places
• Risk appetite is very high around the world
• There are two specific risks in the global investment
environment: Oil and the US Consumer.
• Oil has implications for the vast majority of otherwise
uncorrelated economies.
Conclusions
• Investment risk should be diversified on international markets.
• Effective diversification IS about finding uncorrelated
investment opportunities.
• This IS achievable, because we don’t live in a unified “global
economy”.
• Avoid the nightmares, then diversify amongst what’s left.
VĂ MULŢUMESC