Noise – it’s all just noise..!

You can't hear markets from here...

You can't hear markets from here...

My brother sent this photo yesterday. It is the view from his current workplace, in Laos. Here is my view…

Lots more noise here...

Lots more noise here...

Sometimes the hustle and bustle of the day-to-day can stop us from seeing and thinking clearly. When considering money issues, this is the most common cause of mistakes being made. It may sound easy to step aside from the ‘noise’ and put yourself into a state of mind that allows you to make value judgements that are sensible and coherent but experience tells us that this is one of the most difficult aspects of dealing with money.

We here at Wealth and Security Planners often have people come in to see us who are simply looking for a ‘third-party’ opinion on the state of their overall finances. Many times, these people are knowledgeable, lucid and particularly capable people who have taken all of the right steps to bring their finances into order. These people are identifying the possibility that their outlook may be influenced by the noise that surrounds them and seeking an external opinion can help to identify if that is the case.

Whether you feel in control of your finances or not – a lot of benefit can be obtained from having another opinion. You may not feel comfortable discussing your personal finances with family or friends, and may find your existing advisers are too familiar with you or the area of your finances that they deal with to be able to give you an overall opinion. Even if you do not like financial advisors, this is an area where money spent can be money well spent. If you are incredibly confident of your own abilities, then think of it in terms of Tiger Woods looking for a coach… Does he look for someone who is a better golfer than him? Does he look for an overall opinion or for specific comment by individual specialists?

Back to the point which drove me to the keyboard…


As we stand here at the tail-end of the Global Financial Crisis, it can be hard to work out where some of those long term planning decisions of the past have taken us. Although there were aspects of the broader markets that were “public doman”, the end result was not really what anyone would have expected. To put an example to that, the property market (listed and unlisted) in Australia had shown returns over a 15 year period that were in excess of those achieved by pure equity. This does not make a lot of sense, as property is an inherently capital intensive area and it would be more logical over extended periods for the cost of this to show up in a reduced return over equity in the form of shares. Using a rough rule of thumb, the market had to drop by a fairly sizeable level to bring the long term returns back to the theoretical expected level. The difficulty with any such issue is timing. The property market had exceeded its reasonable level of return for many, many years. Arguments were put forward to explain this – issues such as securitisation and increased capital values from the greater flow of funds towards the sector were justifications for a continuation of the trend. The opening up of international property markets to securitisation was yet another reason for optimism. The yields had fallen (taking a simple bone-headed subjective assessment that property should be returning around 9% yields and residential property should be returning around 6%) but this also was justified by the growth factor. A person who identified this issue would logically seek to limit their property exposure to either broadly diversified portfolios or very carefully selected properties or property managers. All of which would have availed the average person of no good whatsoever. The listed property market fell around 80% while the direct property market (eventually) succumbed to substantial falls. Residential property was spared in Australia owing to the immediate impact of lower interest rates and a lack of new home construction to deal with a growing population.

To distill that lengthy example – if you thought that the property markets were overvalued by 30% then you could have built in an expectation of a fall of up to 30% in your portfolios. However, if you are dealing with listed securities, would you have also built in an expectation of a 50% fall in the broader market (which would result in property trusts falling the 80%)?

In another example, you could have identified that lenders were not applying appropriate risk premiums to their loans – there was plenty of evidence of this, ranging from long term mezzanine financiers returning capital to investors because they could no longer compete with banks through to the valuations being paid for long term income streams (ie, valuations placed on infrastructure assets). Even if you could see this, would you logically have drawn the conclusion that the banking system would collapse (not ‘nearly collapse’ – it did, in fact, collapse).

The Global Financial Crisis involved a banking panic that threatened the entire capitalist money system, and i’m not going to get into arguments about how it didn’t collapse and that somehow illustrates that the system is ‘ok’. That banking panic threw into stark profile the risks being taken in the overall system – risks that were not appropriately accounted for and which could not be controlled or regulated. And so we had people lined up in huge queues to take their cash out of the bank (think Northern Rock), BILLIONS of dollars being electronically transferred out of money market funds and situations in which banks refused to lend to other banks – in effect blocking the essential balance-up that occurs in cash transactions across the world.

In the midst of such dislocation, it is reasonable to ask whether some long-held assumptions should be brought into question. Is it logical that equity outperforms property? Should equity transactions or property transactions be preferred over cash when there is capacity to lose 80% of your value? Would i be better placed making my own calls on what to do with my money – it seems that the professionals got it wrong!

Many people saw the fall in market values as opportunities to purchase assets at reduced prices. Individuals took ‘punts’ on companies making it through the turmoil or put in offers on properties that were significantly lower than recent valuations. Some of those people are now sitting on very large returns, as the sharemarkets have lifted around 50% from their lows and particular properties disposed of in panic have returned to higher valuations as the economic shock wears off.

Many fund managers and professionals were limited in their ability to take advantage of the falls, either through restricting mandates (which is not a bad thing), reduced cashflows or even excessive redemptions. As an example of this, there is anecdotal evidence of super funds asking the regulator for special exemptions to help them work through cashflow issues.

Another impact of the GFC (i’ve had to lapse to the shorter form to help my poor typing fingers) is the completely ridiculous position of global funds moving to the United States currency as protection in the downturn (predominantly produced by and residing in the United States). The result was a massive dislocation of currency markets. The Euro to the $US ratio has swung by huge levels since the Euro was introduced. The Australian dollar has been the whipping-boy of whatever global capital was left after primary allocations were taken care of, a situation exacerbated by the wildly gyrating commodity price movements.

The end result is most apparent for investors in International Equities. If their investments were not hedged to remove currency risk then the overall returns have been basically demolished. To guage an idea of the extent of this, consider the 7 year compound returns from International Equities ( 0.28% ) versus a fully hedged International Equities exposure ( 7.13% ). i have simply used the Vanguard investment fund indexes to come up with these figures. Think about this a little. Over the 7 year period to 30th September 2009, $100,000 would have (grown?) to $101,976 in an International Index fund whereas that same $100,000 invested into a Hedged International Index fund would have grown to $161,948. It takes a patient investor to sit by for 7 years and wait for the markets to ‘balance’ up and return to the mean (average) return… How many people are that patient?

What are the key points of all this, a reasonable person would be asking by now…?

Firstly, portfolio theory is based on measures of markets over extended periods and a broad assumption that individual sectors will revert to their mean (ie, return to the average long run return) over time. During those longer time periods it is logical to expect periods of extreme dislocation – that is how the capitalist system works, and from a historical viewpoint it is also the way that non-capitalist systems work – except they tend to show distortions over longer periods followed by complete system fracture.

We here in Australia have weathered the GFC particularly well. There have been individual sectors that have felt the full brunt of the global crisis but the overall economy has remained insulated to a greater extent than would be expected in such a small economy. If i have to listen to another person explain that our markets (sharemarkets mostly) have lifted in response to our better economic position than other developed countries then i may just start inserting pins into my eyeballs… If this were remotely true then why does our market illustrate a return that is commensurate with other developed countries that are (apparently) basketcases when compared with Australia? A better evaluation (using my very subjective and rather superficial) observations would be that Australia has benefitted from the longtail of global capital being redirected to us quite early in the piece and our small size resulting in that capital being enough to keep us out of the manure.

In other words, methinks it is predominantly luck. If you doubt me, take the time to graph Australian house prices against those of the United States and the UK. Capital is capital, and capital in Australia buys you considerably less over time than equivalent capital in those countries would have done. Arguments of supply/demand only partially redeem the issue, and do nothing to bring into question the assumption of luck being the key player in all of this.

So, in amongst all of this noise, how do you make decisions? How do you know what is right and what is wrong? Who can you trust in a time when the need for capital is seeing bias, entrenched self-interest and undisclosed influence guide many corporate and social decision making processes?

Who indeed.


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