Multi Currency Portfolio Risk Aversion


Multi Currency Portfolio Risk Aversion can be seen in the latest review of the five multi currency portfolio’s we have tracked since November 1, 2006 (eight months).

Portfolios 2007 Mar 27 Apr 30 May 11 June 1 June 15 June 28
Swiss Samba 16.15% 26.60% 32.86% 41.46% 44.13% 44.80%
Emerging Market 12.81% 32.46% 31.13% 40.38% 42.72% 54.31%
Dollar Short 20.12% 30.79% 30.44% 31.84% 29.34% 33.81%
Dollar Neutral 16.58% 25.58% 28.54% 32.26% 33.29% 37.64%
Green 86.86% 135.11% 142.42% 170.33% 173.58% 178.28%

All five portfolios rose again. This suggests that risk aversion in the market is still low. This suggestion is further enhanced by the fact that the three all or mainly equity portfolios (Emerging, Samba and Green) are running well ahead of the two mainly bond portfolios. All of these global portfolios are looking great right now.

One lesson here is about three fundamental global economic trends.

The first big trend is the growth of green. As the world becomes increasingly aware of our environmental plight, more investors will invest in environmentally based businesses. This may be the biggest fundamental trend taking place now. The Green Portfolio has blasted past everything else.

This is not an emerging market portfolio either. All six shares in this portfolio are listed on major exchanges, ( Denmark , Japan , France , Singapore and Germany ).

The second big trend is the growth of emerging markets. The high rise in the Emerging Market and Swiss Samba Portfolios show that this trend is still strong.

The third big trend is away from the US and greenback. The Dollar Short and Dollar Neutral Portfolios are essentially well diversified, mixed, equity and bond, non US dollar portfolios. Though they lag well behind our three equity portfolios, no investor should feel bad with a 30+% return in eight months.

Here however is a word of warning. It’s become common knowledge that leverage has a dark as well as bright side. USA Today’s article in yesterday’s Money section covers how two Bear Stearns hedge funds have trouble after borrowing to invest in sub prime real estate bonds.

The article says: “Leverage, the financial tool that has fueled the private-equity buyout boom and helped hedge funds amplify returns is now being viewed more cautiously by professional investors.”

Just because an article in USA Today says so, does not mean this is true but this is one more warning that “the good times do not roll forever”.

This is why we always warn, never leverage more than you can afford to lose.

I have had several readers send me notes about sub prime bonds and especially about Brookstreet Securities. The OC Blog says “Brookstreet Securities Corp., an Irvine broker-dealer, has shut its doors, laid off 100 local employees and liquidated its assets because it is unable to meet margin calls on complex securities called collateralized mortgage obligations, the company’s spokeswoman Julie Mains told Register reporter John Gittelsohn today. An email sent to employees summed up the situation as a “Disaster. It’s heartbreaking,” Mains said. She said the company went from $16 million in capital Friday to being $3 million underwater Wednesday because its clearing firm, National Financial Services, sold the securities, which had lost value as Wall Street confidence in Bear Stearns & Co’s hedge funds of mortgage-backed securities collapsed .”

An email letter with a purported copy of a letter from Stan Brooks, the founder of Brookstreet says, “This firm has done a valiant if not Herculean job of managing the liquidations and capital charges to the firm’s net worth and net capital. We had reduced the margin balance significantly; we had liquidated and reduced exposure by 80%. That still left a $70,000,000 margin balance against around 85,000,000 of value. Unfortunately the pricing service used by NF revalued many CMO positions downward last night. We went from a positive net capital of 2.4 million, down from 11 million at the end of May, a negative net capital of 2.1 million.”

What this means is that Brookstreet had $85 million of assets as collateral against a $70 million loan. The assets were in sub prime mortgage bonds and the bank that held these assets and had issued the loan, sold or revalued the assets for fear that their value could drop further.

The sale and revaluation did not realize enough to pay off the loan. This left Brookstreet with a loss. This loss was big enough to shut the firm down. The email purportedly from Brooks said: “It would take a capital infusion of at least $5,000,000 to keep the company in compliance with no guarantee that additional markdowns will not be forth coming. I cannot in good conscience request that anyone put money in the firm, I think $10,000,000 could be a minimum without consideration of the horrific customer complaints to follow.”

In other words the owner of the firm expects that the value of these bonds will fall even more.

Even though I was not able to confirm the validity of Stan Brook’s letter, I share this for three reasons. First I have seen numerous meltdowns of this nature over the past 39 years to know that this could all be true. There is nothing special or unusual here. This is an often told “at the end of a boom” story.

Second, the sub prime mortgage business is in a mess. Billions have been, and more will be, lost. Brookstreet appears to be a very small drop in the bucket (though I am sure the 100 employees and the clients of Brookstreet suffer no less). This problem could splash into a much larger arena and create greater risk aversion sentiment. This could cause the riskier segment of any equity or bond market to drop.

Keep in mind that the sub prime market losses could have a positive affect on green, emerging and non dollar investments. Investors who have had capital in subprime could switch to these other strong fundamental trends looking for continued high return. If so our five portfolios could rise even more.

When such high returns and so many warnings make an investor nervous, one way to reduce risk is to take some profit and use it to reduce leverage.

A good three-step, risk avoidance procedure begins with the first step of keeping a closer eye on your portfolio. Perhaps a spot check everyday would make sense. Twice a day is better. Second, set rolling, partial stop losses. Many investment advisors suggest a 25% stop loss position. In other words sell a position if prices drop 25% from its high. Most stop losses can only be made for up to a month so once a month reset your stop loss.

Partial stop losses can speed up or slow down the process. You can, for example, sell a third of your position at a 15% drop, a third at 20% and a third at 25% to speed up or sell third at 25%, a third at 30% and a third at 35% to slow down.

Third, when the first partial stop loss kicks in, reduce leverage as well. Use the proceeds from the sale to reduce our eliminate debt.

Keep in mind these five portfolios we track for educational purposes have very little leverage compared to what Brookstreet was doing. They had $70 million of debt backed by only $85 million of assets if the figures above are correct.

Compared to Brookstreet’s debt to value ratio, the leverage in the Green Portfolio for example is very low, $200,000 of debt on $300,000 in assets when it began. Now the portfolio has $191,762.64 of debt and $470,047.67 of assets.

However if one sold a third of the Green Portfolio, the sale would generate $156,682 and reduce debt to $35,080 with $313,365 in assets remaining. This would essentially make this a portfolio without leverage.

Leverage is nice, when it works. We are pleased as punch to see the Green Portfolio up 178%! However this same portfolio without leverage is a well diversified equity portfolio in strong major market shares that has risen over 50% in eight months. That is not bad. In fact it’s quite good.

Until next message, may your global investing be bright!

Gary

See attached file.

We analysis these five portfolios, plus introduce the 2008 portfolios at our next two International Investing and Business Made EZ courses.

Join us September 14 – 16, 2007 in North Carolina , http://www.garyascott.com/nccourse

Or come to Ecuador November 9-11. See http://www.garyascott.com/catalog/IBEZec/


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