Reaping the rewards of a volatile market

Business - February 20th, 1998

Magellan Tresidder Tuohy (Japan) Limited provides per­sonal investment advice to international investors. In addi­tion to core financial planning areas such as portfolio manage­ment, retirement, education, protection, house purchase and estate planning, MTT is well positioned to advise on a range of structured “alternative” in­vestment products. Many of these strategies are particularly suitable during difficult and volatile periods.

During this year, MTT will be writing a series of articles designed to help readers focus on specific financial planning issues. High on the priority list however, is an introduction to how investors can obtain greater peace of mind with their investment strategies, in view of the expected continued stock market volatility during 1998— and perhaps beyond.

Many of you may be won­dering what to do with invest­ment monies. There are a range of investment options available that seek to provide attractive returns commensurate with a low-risk approach. These re­turns actually capitalize on market volatility.

This doesn’t mean investors should not include equities in their overall portfolio. Never­theless, including “alternative investment structures” which show a low correlation to the more traditional asset classes such as stocks and bonds, can often enhance overall returns— particularly now—in a volatile market.

Almost all investors should seriously consider including hedge funds and capital secure funds in their portfolios. The em­phasis is on controlling risk pro­viding significant advantages over the more traditional invest­ments in turbulent times.

This first series presents some basic definitions of hedge and capital secure funds. Two case studies simply outline how these types of funds were in­cluded in two different inves­tors’ portfolios to provide both diversification and protection against volatility.

What is a hedge fund?

In simple terms a “hedge fund” is a fund which can make profits on both rising and falling markets by taking “long” or “short” positions. (The former to make a profit when the mar­ket goes down and the latter when the market goes up.)

A diversified hedge fund will simultaneously trade in the global currency, foreign ex­change, precious metal, com­modity and interest rate mar­kets among others often by em­ploying a number of managers. Hence these funds are not con­fined to the stock markets.

What are Capital Secure Funds?

These can include:

  • Funds linked to stock mar­ket indices which allow the in­vestor to participate in the gains of the market while protecting the downside.
  • Funds secured by low-risk financial instruments backed by AA+rated western banks, there­fore providing original capital security plus profit participa­tion from simple interest earn­ing investments.

Why weren’t these recommended to me years ago?

Simply, they were not avail­able to the private investor. However, many institutions have been successfully utilizing hedge funds and funds employ­ing “Stop-losses” for many years on behalf of institutional pension funds.

These funds have become available to the private inves­tor because of the presence of independent brokers such as Magellan Tresidder Tuohy, who have established a demand for sophisticated products at the private investor level.

How should investors look to employ these strategies with their own financial situation in mind? Here are two case studies.

Investor A:

Receives an annual bonus. She has worked in Tokyo for one year. She has $60,000 to invest reasonably aggressively for a minimum of five years. Investor A has doubts about which mar­kets offer the best opportunities for 1998. She also needs to take advantage of her monthly sur­plus income. Her comfort level was $1,000 for monthly investing.

Investor A believes she can manage her own portfolio and, even though she has doubts, does have some special stock market interests.

MTT advised:

In this case, MTT recom­mended that $40,000 be placed with a professional portfolio management institution which would select and actively man­age a global balanced portfolio of equity and bond funds, free­ing Investor A from the respon­sibility of keeping pace with the markets.

MTT also recommended a leading highly diversified hedge fund, which employs 20 world-famous managers for the balance of $20,000 which could be con­solidated into the same portfolio.

To satisfy Investor A’s inter­est in emerging markets, it was recommended she make use of a monthly savings plan which provided access to a wide range of funds exposed to her area of choice. The ability to remain flexible was important and switching fund choice was possible at any time.

Investor B: (a married couple)

As extremely cautious inves­tors, they have a portion of their savings to invest for the first time—$225,000. Capital protec­tion is important as well as no involvement with ongoing management.

MTT advised:

A 3-5 year minimum time horizon, preferably longer, was advised to maximize the ben­efits of gains.

It was obvious that Investor B would be most comfortable with some built-in “guarantee” and that this level of guarantee was to be determined at the ou set. With this in mind MTT se­lected a portfolio of stock mar­ket-linked funds, each with a rolling 95%-97% capital guar­antee and which provide quar­terly “dividends” whenever the stock markets rise. This pro­vided peace of mind and yet significant earnings potential.

The next article by MTT is scheduled for March and will provide more specific informa­tion about the use of hedge funds and their alternative in­vestments.