Gyrations rock world markets...

On April 4, US equity markets performed what can only be described as wild gyrations.

Are these good gyrations?

By Rodney Green

Chief Executive

Perpetual Investments

On April 4, US equity markets performed what can only be described as wild gyrations.

The Nasdaq fell sharply during trading but had largely recovered by the end of the day. At its low it had plunged 14.8% from its opening, its largest ever intra-day percentage decline.

Yet the Nasdaq recovered in afternoon trading to end the session only 1.8% lower on the day.

At the low, the Nasdaq had dropped 21.2% in two sessions, similar to the volatility of 1987.

The less speculative Dow Jones was also chaotic and particularly volatile — up 196 points or 1.8% initially, then falling 4.5% (504 points) before recovering to end 0.4%, or 46.85 points, lower. Throughout the day, the Dow traded through a range of 700 points — its largest range ever in a single day.

What can investors learn from this and is there anything they can do to protect themselves from such gyrations?

I suggest that market gyrations are something that we must learn to live with. The human emotions of fear and greed dictate that this must be so. Loose valuation principles, which have gone hand in hand with increased investor interest in start-up technology and internet companies, has now been well documented. Problems associated with valuing companies that have no demonstrable management and earnings track record, have also been the subject of discussion.

Such factors have combined to create a great deal of hype, thereby propelling the value of many technology-flavour companies to seemingly unjustifiable levels (the greed factor). Meanwhile, the fear factor lends itself to a similar proportionate downside risk for the value of the more speculative companies.

Traditional stock selection fundamentals - such as strength of management, strong balance sheets, and a track record of sustainable earnings — have been somewhat forgotten in the clamour for speculative gains.

I have no doubt that as a result of this, volatility has, and will, increase. For long term investors such gyrations may cause bouts of nervousness, but can generally be ignored.

As always, advisers have a key role in investor education, overcoming their nervousness and helping them stick to agreed investment strategies and principles.

At the moment it is fashionable to divide equities into categories — such as old economy and new economy - with the old economy being “bad” and the new economy being “good”.

The realities of investing are not always that simple. Many so called “old economy” companies have a substantial place in the future.

We will still need white goods, food and drink and a whole range of products and services. Many “old economy” companies also have a foot firmly in the “new economy” through their technology exposure.

In that sense all companies are becoming technology companies because of the benefits that newer technology can bring to their business. Technology has an undoubted role to play. However investors still need to focus on the company’s ability to generate profit and create shareholder value.

What does all this mean to advisers and their clients?

When it comes to investing in equity funds the rules have not changed. Investors need to know the investment criteria of the fund, whether the manager is applying them diligently, and whether the fund is performing well against the appropriate benchmark or similar funds.

It is a time when investors should look carefully at risk/reward values.

However the pressure on performance and publication of monthly league tables may tempt some fund managers to invest in more speculative companies which, in different market conditions, they may have considered as being outside their funds’ investment style.

Unless funds remain true to their process it is difficult for advisers and their clients to know what they stand for. A well structured investment approach based on company specific fundamentals should allow exposure to, and result in benefits from, technological developments.

Perhaps advisers should encourage their clients to follow the example of institutional investors. Institutions are no less focused on performance but develop a portfolio structure that includes different fund manager styles, with the end result of a smoother ride for investors.

Generally, fund managers selected by institutions are given at least a three year time frame to prove their performance and are always assessed against the style for which they are selected.

This approach of selecting fund managers with contrasting styles to build a total portfolio tends to smooth out market volatility and help avoid being caught by market gyrations.

Converting this approach to the retail market means that advisers should encourage clients to adopt a similar approach and time frame. In this way, advisers and clients will benefit by setting manageable and realistic expectations, consistent with their investment goals.