Strategy during crisis investment

Strategy during crisis investment by Ang Kok Heng

When market was high, many investors were careful and avoided jumping onto the bandwagon. Now that the market has fallen, and fallen sharply, many investors are still wary about investing. There is nothing wrong about being careful with one's hard-earned money. Not unless our interest rate falls to 1%, like in the case of US or close to zero in Japan.

The only problem with extremely cautious investors is that they kept their money in banks most of the time. They sighed with relief for not being caught by the market. While they escaped the bear, they also missed the bull. Many Malaysians witnessed the bear and bull during the ups and downs of the economy. Nothing happened to them as they did not suffer any losses and neither did they gain anything from these cycles.

No crystal ball

Many investors were cautious because they do not have a crystal ball to predict where the bottom of the market is. Unfortunately, there is no such thing as a crystal ball in the investment world.

Everyone is faced with the same dilemma. Even the professional investment fraternity cannot predict the market accurately. The only difference between a layman and a professional is that the latter is equipped with a bit more information and some knowledge about investing. But their vision is also limited.

They can only see a few feet ahead. Their vision becomes hazier further away from the target. Beyond certain circumference, they probably cannot predict what will happen. Whatever they forecast is purely based on a set of assumptions which may or may not be valid. As such, the predictions of many analysts and fund managers are nothing more than their own assumptions.

Travelling on rainy night

Investment is like travelling in the rain at night. Some may park their cars by the side of the road during thunderstorms while waiting for the rain to stop.

This is especially true for those with astigmatism and poor night vision. They know they can only travel on a rainy night if they have their vision corrected.

Some will drive very carefully in the downpour due to poor condition of their wipers. They know that they are not equipped to speed before changing the wipers.

For those who are well equipped and familiar with the road conditions including the bends and nooks, they can drive on with reasonable speed. Hence, they arrive home early and safe. Getting home safely is important, but getting home early is definitely an achievement. For those who are less equipped, it is better to get someone who knows how to drive to take over the wheel.
In investment, one must be equipped with the basic investment knowledge and familiar with the investment conditions. Otherwise, the road ahead could be treacherous.

Let the savings work

The ability to grow one's money is definitely crucial especially if we look at how inflation has eroded our savings over time. Gaining a higher return over one's savings not only can help overcome the erosion due to inflation, it also helps to build up a higher reserve for retirement.
Most financial planners encourage people to save and save early so that the compounded return on the savings can accumulate to a substantial amount leading to financial freedom.

While it is true that early compounding is crucial to amass a pile of wealth, having a higher average return from the investment allows us to achieve the target earlier. The question is how to get our savings to work harder for us.

Crisis means opportunities

The prevailing financial crisis in US may provide the much-desired opportunities. The Chinese character for crisis means danger and opportunity. These meanings must have been coined many years ago based on the Chinese' experience. The explanation can be seen as a clue and it has helped many successful people to make huge profit.

"Buy when markets hit the point of maximum pessimism." — Sir John Templeton

For those who have been keeping their savings in the bank, the opportunity arises during a crisis. Their patience eventually becomes fruition. The day of recognition finally arrives and their prayer is answered. Ironically, many who have patiently kept their savings in the safe cradles become more protective of their savings and they just stood by the sidelines, watching the crisis comes and goes. It happened in the past and it is happening now and it may also happen in the future.

Market chaser — a loser

On the contrary, there are also certain groups of investors who always chase the market. They get excited whenever the market runs. They are overwhelmed whenever the bull is in town and they tail behind the bull. When the bull is gone and the bear returns, they become fearful. They hide at home and cuddle whatever balance they have in their savings.

"The public buys the most at the top and the least at the bottom." — Bob Farrell's Rule No 5

As a whole they put in more money during the bull market than in the bear bottom. Some even cut lost after a substantial fall in prices. In a way they "buy high and sell low", whereas the basic rule of investment is to "buy low, then sell high" — a simple investment tenet understood by most people, but not being widely practised. Although we may not know where the bear bottom is, buying in a down market may still lead to losing money. This is definitely true. As long as the purchase is not at market bottom, it may still result in losses for the time being. This is likely to be a short-term loss but compensated by a probable long-term gain. Even if we cannot time the market perfectly, we are definitely better off to "buy low and sell high" then to "buy high and sell low".

Prices fell but value intact

Presently stock prices have fallen sharply. Banks are trading at 1x book value, property stocks sold at 50% discount from net asset value, utility stocks trading at single-digit price-earnings ratio providing an earnings yield of more than 10% net of tax and there are many good stocks trading at dividend yield of 2x bank interest rates.

While prices have fallen off the cliff, the values of these companies are still very much intact. The present financial tsunami in the US has its impact on many Malaysian companies. It will cause a slowdown in our economy and affect earnings over the next one to two years. But isn't this part of business risk? Established and proven companies have weathered this many times as in the past and they will eventually end up bigger and stronger.

Prices may fall but the value of a good company is still very much intact. The value of a company comprises the brand name, business contacts, the team of suppliers, the network of clienteles, the internal management control, the technical skills and etc.

Warren Buffett is busy buying

Warrant Buffett, the second richest man in the world who makes his fortune from stock investment, is busy buying undervalued companies. He sees the value and he also sees prices detaching away from the intrinsic values. He said: "I haven't the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turn up."

Although we may not be able to imitate exactly what he is doing, we can still follow some of his investment strategies. There are a few strategic moves that he has employed in the current financial crisis:-

• He is able to buy those shares which he likes in the past at a huge discount to the net worth, which means his safety margin at this point is very good.

• He aims to hold the investments for several years for huge profit margin as he is unlikely to sell for a small profit.

• He does not rush in to buy, he is very selective on the stocks he bought.

• He buys gradually. Thus far, he only uses about half of the cash balance in Berkshire Hathaway, his flagship company.

While others witness the collapse of banks in the US and wonder which one will be the next to fall, Buffett discovers many cheap buys. When Alan Greespan said this is a once-in-100-years financial crisis, Buffett believes this is a golden opportunity to accumulate undervalued stocks for his collection.

Catching a falling knife

Some may argue that buying now is like catching a falling knife. If you are not careful, you may be hurt and suffer more losses from falling stock prices. There is no doubt that we may incur short-term losses as long as we do not buy at the bottom. On the other hand, who can determine where and when is the bottom. As long as there are still unknown events or hidden problems, an apparent bottom now may not be the eventual bottom. Since we do not have all the information in the market, it is almost impossible to guess where the bottom will be.

In most cases, we only realise the bottom after it is over and by that time stock prices are running high with much improved market confidence. Market bottom could be there only for a short period. In most cases, market did not stay at the bottom waiting for investors. It will just move on.

Since market moves ahead of the economy by about six months, the market bottoms out when the economy is still gloomy, news are still negative, analysts are still calling underweights and most investors are staying at the sidelines.

In the absence of a crystal ball and in order not to miss the market bottom, it will be more profitable if we learn how to catch a falling knife. The good thing about a falling knife is that, we know it is a falling knife. So, we only need to use some precautionary measures to avoid being slashed by it. Handling something we know is definitely much easier than dealing with the unknown risks, something which hits from behind without warning. When we invest during a crisis we actually go in with our eyes open. We know it is definitely risky but we also know it could also be very profitable. If we can handle the risk, the risk-reward trade-off will be very rewarding.

Emphasise strategies

What we need is to buy near the bottom, not right at the bottom. Investors' frequent question now is when to buy, that is where is the bottom? Perhaps it is more intelligent to ask how much to buy now since nobody will be able to guess where is the market bottom. Even if someone provides advice for market timing on when to buy, how can we trust he knows the answer. He is probably doing it as a favour in order not to disappoint the enquirer with a negative answer — "I don't know" (which is a fact, unfortunately), or he is probably guessing based on some assumptions.

Staggered buying is preferred over bullet purchase which is taking the risk of timing the market bottom. In staggered buying, a pre-determined amount will be set aside for investment over time, say in 10 equal portions.

One common method of staggered investment is dollar cost averaging, an investment scheme made in equal portions periodically, either by a small amount monthly or larger amount quarterly. There are also several variations of staggered investment.

The investment portion can be modified to x percentage of cash balance, say 10% of available cash balance. An investment of RM100,000 will start off with RM10,000 in first purchase, then RM9,000 in second purchase (ie 10% of the RM90,000 cash balance) etc. This method will stretch the money over a longer period.

Other than equal interval investment outlay irrespective of how the market performs, timing of the next staggered investment will only be made if the market dips by say 5% or by 50 points.
For more aggressive investors, a 10-equal portion of investment could be finished before market hits the bottom. This could happen if the market takes longer-than-expected time to recover. On the other hand, a more conservative investor may be investing too slowly and the market may have rebounded before he or she has invested half of the money set aside for investment. This could happen if the market rebounds faster than expected.

Anyway, staggered purchase is a preferred method to avoid the anxiety of market timing and the mixed feeling of fear of further downside and worry of missing the market rebound. As long as the market is undervalued, the strategy of staggered investment ensures that investors are in and are benefiting from the undervalued market.

Ang has 20 years' experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.