How to manage risk & return in turbulent times, part 4
The asset-backed solution
The other alternative is to identify assets with similar investment
characteristics to cash but which produce higher returns. Asset-backed
investments generally provide a reasonable level of security depending on
the underlying assets in question although in many cases liquidity is
compromised. There are some exceptions to this including our own current
preference. This is the Two Seasons 21st Century Fund which consists of
tangible assets such as residential and commercial property or the assets of
businesses such as plant, machinery or stock. The levels of security are
determined by the price stability of the underlying asset. Residential
property is generally the preferred security. In the safest and most liquid
asset-backed investments, the ability of the underlying asset to source
alternative funding is a key factor in ensuring an acceptable level of
The actual return on the fund is not in any way dictated by the returns or
income of the asset itself which is merely held as the security if the
interest and/or capital payment obligations to the fund are impaired in any
way. This is similar to the way that building societies and credit unions
issue loans using depositors’ funds and take security against these.
However, the main differences are that the funds do not leverage their
exposures, so the levels of security held by the funds are much higher than
those generally required by most building societies and credit unions. Also
the underlying quality of the credit issued by the funds is a much higher
calibre than most credit institutions yet the resultant returns are
There has never been such a difficult period for investors and analysts to
‘join the dots’. The risk on/off phenomenon is the manifestation in capital
markets of the battle between economic fundamentals and the artificial
effects of intervention. The massive debt levels of households, the banking
sector and government debts are slowly but inevitably strangling the
economic system. This is not a short-term phenomenon nor is any quick fix
likely - hard, painful decisions are required but are unlikely to be
forthcoming. Economists can only try to explain what is happening while
investors need to play the card that they have been dealt. If they follow
the conclusions of this guide, we expect investors to significantly
Political factors rather than fundamental factors currently drive markets
but the artificial recovery manufactured by prolonged distortion of economic
rules will ultimately have to face reality.
Central bank policies so far have generally taken the exact opposite path to
the one required to deal with the economic downturn. This course of action
is leading to another, larger crisis down the road.
Central banks and international organizations have used specious
justifications and distorted precedents to justify their actions. Academic
research is distancing itself from this and appears increasingly
uncomfortable with the adopted policies.
Last year, and for the last decade, it has been vital to understand the
economic context in order to achieve best risk-adjusted returns. The global
economy is in a ‘winter’ phase.
The “new normal” - slow economic growth, increased volatility and
disappointing investment returns - seen in 2011 is a taste of what is to
Winter gives rise to counter trend relief rallies in risk assets but
investors who tactically exploit this need to be careful not to get caught
“picking up Nickels in front of bulldozers”.
Investors who study economic history will be able to better anticipate the
pending calamity than those who have blind belief that the unprecedented
experiment currently being conducted by central bakers can, and will, change
the essential nature of economic cycles.
The mess that led to the credit crunch and the GFC has never been tidied
away or dealt with - only swept under the carpet.
Europe is a disaster waiting to happen at some point, even if the can could
be kicked further down the road.
If they do not get things right then China may be a greater problem than
Europe. Strategic asset allocations should be to cash, gold and fixed
As the end of winter gets closer each day, investors need to be aware of the
potential need to exit these positions in the future but winter is likely to
persist for a number of years.
Cash has less potential downside than gold or bonds but cash returns are
extremely meagre. It is vital to maximize returns from cash holdings without
compromising security or liquidity.
The two keys to enhancing cash returns are either to exploit long term
currency trends or to identify assets with higher returns which also offer
Currency trends have been, and continue to be, most successfully implemented
by Martin Gray within portfolios such as Special Situations, Strategic and
Rhodium, all of which have moved from exploiting Yen strength to investing
in Asian currencies.
The few asset-backed investments, such as 21st Century, that provide
adequate security and liquidity provide the best cash equivalent
Whilst the environment is challenging for investors, it is not impossible to
stay ahead of the curve and keep your future in your own hands.
The above data and
research was compiled from sources believed to be reliable.
However, neither MBMG International Ltd nor its officers can
accept any liability for any errors or omissions in the above
article nor bear any responsibility for any losses achieved as a
result of any actions taken or not taken as a consequence of
reading the above article. For more information please contact
Graham Macdonald on [email protected]