Turbulence shakes up risk assessments

A new year might be a fresh start for some, but not for the global markets, which have continued sliding in the early days of 2008.

Since January 1, the S&P/TSX Composite Index has dropped nearly 10%, or 1,241 points, and more than 16% from its 2007 peak on October 31. Things were looking a little better on Tuesday, but that’s likely due to central bank rate cuts — 75bps from the U.S. Fed and 25bps from the Bank of Canada — than anything else.

This recent market volatility has caused Eric Sprott, CEO of Sprott Asset Management to say that 2008 has “started off with the markets’ worst fears coming to fruition — namely, the realization that the global credit boom was nothing more than a massive pyramid scheme that is now toppling like a house of cards in a stiff breeze.”

He says that so far this is the worst January in recorded history and “barring an end of the month rally, such a January hasn’t occurred in over a century.”

Needless to say, gloomy pronouncements and rapidly falling stock prices are causing investors to panic yet again. Advisors might be feeling the pressure to act too, but in times like these, it’s best that everyone stay calm.

“I have some clients that are very worried,” says Orville Acton, a Saskatchewan-based advisor with Edward Jones. “The most important part of my job is to make sure they understand what is going on and that the long-term financial plan we built is still intact.”

“There’s no question that we’re in a financial crisis,” adds Andrew Cook, a portfolio manager at Marquest Asset Management. “But we don’t think it’s time to panic.”

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Still, that’s easier said than done. Cook didn’t want his clients to get themselves worked up, so he sent a letter out Monday night telling them that investing long-term is the way to go and the company is looking for new buying opportunities.

Acton has been working overtime too, calling many of his 450 clients to tell them that there’s no need to start sweating. “I’ve been counselling very strongly that my clients sit down and take a dispassionate look at what’s happening this time and what’s happened in the past,” he explains. “My job is really to keep them invested, if the investments are appropriate.”

Warren Jestin, Scotiabank’s chief economist cautions that “panicking always leads to locking in losses on investments.” He says an upside to the market volatility is that investors and advisors can pick up cheap equities.

“One thing that’s going to be there at some point in time is a big buying opportunity,” he says. “If the U.S. economy turns a corner … the equity markets will anticipate that. But with the financial setbacks and economic news, we’ll see what happens.”

Cook isn’t waiting to see how things play out; he’s already scooping up stocks in a variety of sectors. On Tuesday morning he bought equities in financials, cyclical materials, energy and tech.

Acton recommends that clients who have a lump sum of cash buy something with part of it today but spread out the rest over the next six to 12 months. He says a good portfolio should have about 10% invested in energy and 18% in financial services, but not just in banks. “Financial services are more than banks,” he says. “It’s global banking giants, insurance companies and money managers. We want 18% across all three of these.”

As important as staying invested long-term is to the health of a portfolio, having a properly balanced set of investments is also key to success. Acton says that investors who have 15% in energy should consider selling some of their position, despite the market downturn. But if they find themselves with 7%, they should be buying.

“If you already own a diverse portfolio of quality investment, then hold on,” says Kate Warne, Canadian market strategist at Edward Jones. But, she adds, also look for opportunities in the consumer staples, retail and financial services sector. And if you’re already overweight in financial services, like many Canadians are, then it might be worth pruning the exposure to that sector. “People need to review and make sure their portfolio is well diversified, so they don’t have too much risk.”

Having too much risk, or an investor thinking he or she is being too risky, is precisely why people are panic selling. If you have a client who is worried or can’t stomach the volatility, it might be a good time to reassess his or her risk profile.

“People get to a point where they say, ‘I just can’t take it anymore,'” says Cook, who hasn’t had this problem with his own clients yet. “If they sell now, they know what they’ve lost and where they stand financially. When the market goes down, people get to know what their risk tolerance is.”

“If they don’t have the risk tolerance they need, then maybe we should revisit that and rebalance more conservatively,” adds Acton.

Even with advisors telling clients to look at their risk profile, stay invested long-term and rebalance their portfolio, it’s only natural that people will feel the pressure to sell. They might know that they need to stay invested, but when the markets tank, people can often make rash decisions.

“It’s easy for people to say, ‘I’m a long-term holder’ when things are fine,” says Cook. “A market like this tests your judgment.”

Acton is feeling the pressure too — not to sell, but to keep in touch with his clients. “I need to stay in touch with my clients as much as possible, and I do worry that some of them are going to make bad decisions in spite of my recommendation,” he says. “I don’t think that will happen with too many, but it will happen to some.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(01/22/08)

Bryan Borzykowski