The question everyone is asking, not just shell-shocked investors, but financial advisers and economists as well, is how low can the Dow Jones Industrial Average go? And the answer is, very, very low. Some pessimists are now predicting the Dow 900.
"We are going to have a very, very tough economic period that is going to last for a long time," said Curtis Arledge, managing director and portfolio manager with BlackRock's fixed income, portfolio management group. As far as the volatility and the sharp daily declines in the Dow are concerned, "the equity market is in the hands of short-term traders, forced liquidation in levered funds" and margin calls, said Andrew W. Lo, founder and chief scientific officer of AlphaSimplex Group, and portfolio manager of the ASG Global Alternatives Fund.
Yet despite the pervasive panic and volatility, or perhaps precisely because of it, now is actually a pivotal time for mutual fund companies and financial advisers to prove their worth to investors by steering them to safe investments that can provide decent yields, even as stocks continue to get pounded.
More importantly, fund companies and their selling partners must begin providing complete, holistic, personalized oversight of an investor's total net worth much like a wealth adviser-including real estate, debt, guaranteed future income, risk management and, last but not least, tax strategies.
That was the consensus of investment management executives who spoke at a recent webcast, "Where to Find Sane Investments in Today's Crazy Markets," sponsored by Fidelity Institutional Wealth Management and its brokerage subsidiary, National Financial.
As Duncan Richardson, executive vice president and chief equity investment officer at Eaton Vance, put it: "Never has the value of advice been higher, to put this market in historical context and to make sure that the mountain of money huddled in cash, generating negative real returns, finds productive outlets going forward."
Understanding risk-adjusted returns will be critical in the years ahead, Arledge agreed. Those asset management firms and financial advisers that can provide this insight to investors will, deservedly, win their business.
So for the time being, at least, the investment story is not one of hiding in Treasuries, cash, stable-value funds or money market mutual funds, speakers said. Investors will succeed in preserving their money in these instruments, yes, but they won't be beating inflation.
Instead, the investment story is, overwhelmingly, fixed income and staples. Among the many bright spots available to investors are: pre-refunded and escrowed tax-free municipal bonds; high-quality general obligation bonds; inflation-linked savings bonds; short-maturity corporate bonds; equities and bonds tied to consumer staples, healthcare and other essential services; non-U.S. fixed income; equity options and stock or bond index futures; closed-end mutual funds trading at wide discounts but that are not highly leveraged; and dividend-paying stocks.
"With the free cash flow yields of the stocks around 7%, you compare that with a long bond, and the valuations in the equity market are compelling," Richardson said, adding, "It shouldn't be forgotten that the dividend stream also has a tax advantage to it, at least for the next three years you are going to file. You might as well take advantage of the rates in a taxable account in equities [before] taxes go up across the board."
Nonetheless, even these investments come with risks and need to be skillfully navigated. "There are yet more landmines," BlackRock's Arledge cautioned. "Over the past month, high yield has gotten repriced dramatically, so you need to have an adviser to navigate that."
But there are many investment opportunities to be had, Arledge said. "Government-guaranteed fixed income instruments are providing identical credit risk as Treasuries but at much higher yields," he explained. Thus, BlackRock is moving many clients into instruments tied to the Government National Mortgage Association (Ginnie Mae), the Federation National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) because "the government is essentially guaranteeing their debt." Arledge and his team think that the government sponsored enterprises and banks receiving capital injections from the government "will issue government-guaranteed paper at meaningfully wide yield spreads to the Treasuries today," the latter of which is only generating between five and 25 basis points.
Lo said, "Diversifying across asset classes, particularly to non-traditional asset classes to deal with this dislocation, is one of the themes financial advisers might consider. The idea is to try and diversify beyond standard asset classes to stock index futures and bond futures, to get exposure to currencies, commodities and a variety of fixed income and equities but in a way that captures the broad-based common factors that hedge funds benefit from, while also allowing investors to come in and maintain a certain degree of access to their investments."
Alpha Simplex is also advocating short selling, Lo added, pointing to how that strategy is largely the reason for hedge funds' 10% year-to-date losses, versus the 40% decline in the Standard & Poor's 500 Index.
If mutual fund companies and their selling partners fail to convince investors to stick with the markets and to come back out of Treasuries or cash-equivalent instruments, Lo warned, "the next crisis will be a generation of indigent retirees who can't afford to retire because of bad investment decisions," moving entirely into cash, never expecting to return to the equity markets.
Looking at the massive inflows into government money market funds, Richardson said, that crisis appears to be happening.
"The mountain of money in money markets is nearly one-third of the market capitalization of the U.S. markets," he said. "Counting bank deposits, that's two-thirds of the U.S. market capitalization sitting in negative real returns."
The smart money, Richardson predicted, will be in equities, because when people least expect it, stocks will "shoot up like a rocket. We are building for ourselves the infrastructure for much, much greater growth beyond. So, there is reason to be optimistic, but it is going to be a long haul."
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