The word which, in our view, would best sum up the whole of last year – and, more specifically, the second half of 2008 – is Mistrust. A lack of confidence in the banking system which is creating a liquidity trap (Liquidity Trap) which is set to have very significant and dramatic consequences for the real economy, society and everyday life. The consequences of mistrust lead to a freeze in the flow of money, and as a result, investors are gripped by terrible doubts: Who are we going to lend our money to so that they can put it to work, whilst ensuring we have sufficient guarantees that they will be able to repay it on time and without the dreaded credit event (Credit Event)? Secondly: For how much money, profit or interest are we going to lend it? And finally: For how long is it sensible to lend our money to the lucky chosen one so that they can put it to work?
The answers to these questions are, of course, difficult and complex. But above all, we must always bear in mind that they must be tailored to the circumstances of each investor or wealth holder. And within each of these, there will be portions of assets that should be allocated in one way or another. Thus, a portfolio should always be allocated across a range of investments tailored to the needs, objectives, preferences, etc. of each individual. What is certain is that, at present, it is prudent to adapt the ‘Vital Balance Sheets’ to investment returns whose risk-return ratio has changed drastically, whilst not losing sight of the possibility of hyperinflation. despite the doubts.
Speaking of fixed-income investments, the flight to quality in 2008, or the flight to safety in terms of the quality and creditworthiness of investments, led to a fall in the returns on the (a priori) safest investments, such as the sovereign debt of developed countries and large, highly creditworthy companies. The simple reason is that when many people want to buy the same thing, its price rises, thereby reducing its yield. Now, almost halfway through 2009, following the mistrust generated by the fact that most companies are facing serious difficulties due to their inability to refinance their debts with financial institutions, many are once again lending their money almost indiscriminately by buying corporate debt issued by these firms. Demand for corporate fixed-income securities has soared over the last couple of months, particularly in recent weeks. And The lack of criteria in the selection process is leading to companies with very different capabilities when it comes to tackling their emissions being priced at very similar levels. Every day we see how large asset management firms and their respective advisers, are recommending programmes that we might call blue-chip companies and which are selected on the basis of criteria as outdated and dangerous as credit ratings or grandiose names. With a few honourable exceptions, issues are selected by financial institutions as suitable for their clients’ investment portfolios, based on nothing more than a very superficial analysis: news, credit default swaps, ratings and little else. And there are very few advisers who take the trouble and the time to study the balance sheets of the issuing companies in order to ascertain their financial capacity, and thus be able to repay the debt without the dreaded credit event. Furthermore, if that selection takes the form of a fixed-income investment fund, we will find that it contains a wide variety of intrinsic risks and lacks any reliable criteria in the analysis used. The result of all this is that, nowadays, bonds from issuers with very different financial situations are trading at the same price. And that distortion has been caused by the abuse of indiscriminate demand in a very difficult environment for safeguarding financial assets.
(To be continued…)