EMOTIONS CAN TOPPLE INVESTMENT PLANS

SUMAIRA FAZAL
Aug 11 - 17, 2008

Imagine you have only one investment portfolio; you don't have money in banks, retirement fund, property, municipal bond, and you expect the highest return on that concentrated portfolio. No, you are certainly taking the wrong path! The promise of abnormally high rate of return may lead to cognitive dissonance. Bad decisions are often followed by a feeling of investor's remorse. Don't put all your eggs in one basket; one decision to rule them all! Yes, the diversification/ allocation of assets are the key for making up with your investments. Asset allocation decision is critical. Get it "right" and you have accomplished nearly 100% of your task in one step.

Investments are made to make money; therefore, investors conduct analysis and take cautious stance while making investment decision. There are many asset classes, including cash, bond, stocks, real estate, commodities, precious metals and foreign currency swap. Each class of assets demonstrates certain return and volatility characteristics. The investor can combine there asset classes in infinite ways to produce infinite return/risk portfolio profiles. The greatest challenge an investor might face is to learn why these asset classes tend to behave the way they do and what influences their performance profile. Many of us know that stocks have tendency to produce greater annual returns than bonds, while at the same time, stocks tend to be more volatile than bonds but do we all know why is that so?! It's simply because that bonds are kind of debt securities and they offer a fix and stable return; whereas, stocks are equity securities and owing to it equity participating nature these are prone to business risk. The more the business will be profitable the higher will be the return of investor. While every individual theoretically has a particular investment psyche, one idea is universal: if you are a rational investor, you want to maximize return and minimize volatility. There is no reason to take on more risk if you are not going to get paid for it through the opportunity for greater returns; similarly, there is no need to seek greater returns than you don't "need". Investors should choose the asset allocation that has the greatest chance of allowing them to reach their goals with the least volatility along the way.

Many private investors' first foray into financial trading in the capital markets is via stock market. It's relatively easy to understand, offers a wide selection, features many recognizable companies and products, and allows investors to "get out" with relatively little hassle. Pakistan stock market had performed tremendously well, evidenced by exponential surge in KSE index. The performance of Pakistan stock market had been far better than regional markets like China and India. Nevertheless, the market showed slowdown during the first half of the financial year 2008. This is attributable to the fact that investors moved from portfolio to the commodity investment and some remained sidelines owing to prolonged uncertainty on the political front and weak economic indicators, and burgeoning law and order situation in the northern parts of the country. However, it would not be fair to judge the performance of the bourse in isolation, as it still outperformed the regional markets. The best way to invest in stock market is to select the fundamentally strong scrip with the holding power for around three years. An investor who will invest in the stock market for around three years will never end up as a loser. This is the positive aspect of Pakistani capital markets. The KSE declined by 13% during 1H08, whereas SSEC of China plunged by 48% and India (SENSEX) dived by 33% in the period under review.

The economy is under pressure, but should not crumble given the buffer built over last few years. Foreign flows should return - mitigating economic woes partly. To top it all, the KSE is still at a discount despite the 25-30% out performance versus the region, indicating downside protection. There is a disconnection between stock exchange and economy. True, there is lingering economic strain, which will effect economic indicators, but the KSE had been somewhat insulated. This disconnect is expected continuing to play out. The sector analysis is an important aspect to make investment decision. There are some perceptions which might help investors better dwell on decision making regarding stocks.

Rising oil prices, a negative for the economy, are positive for oil stocks, which make up to about 25% of the KSE index.

Favorable budgetary measures for fertilizer sector, may lead towards higher profitability of the sector; thus, indicating opportunities to get better investment return from this sector.

Banks are having higher spreads on their financing, outperforming all other sectors. This suggests it's always a good idea to invest in financial sound and big size banking institution.

Increase in cement price globally means cement manufacturers in Pakistan might realize better export prices. In the wake of raw material price hikes, the net benefit of the commodity boom would be a function of regional shortages, which are currently working in favor of cement manufacturers - at least in the short run until the supplies come online.

As regards investment products offered by Pakistani banks, these institutions are offering very limited products; mainly two (i) saving accounts and (ii) term deposits. Term deposits have tenure ranging from three months to five years, and the rate of return varies according to the term of the deposit. The longer the tenure would be the higher will be the return. The important thing to realize here is that the return on deposits banks offer is so very low that hardly reap any benefit to the depositor, with even more thin rate of return on saving accounts. So, if some one says "I am going to invest all of my money in form of bank deposits", he will be going to deprive of benefits he might drive from other avenues, as ignorance is not always bliss! Further, in a move to fund government expenditure from non banking sources, the rate on government's instruments has been increase, which will certainly give intensified competition to the banking deposits.

An emerging area banks have embarked upon is investment in mutual funds. In Pakistani market different kind of mutual funds are being offered by banks and other financial such as, income funds, stock/equity funds, Islamic funds, balanced/ asset allocation funds and pension funds. Mutual funds are an appealing method for individual investors to participate in the outcomes of a large basket of stocks. The money pooled by mutual funds is invested by professional asset managers across multiple sectors, and their increased size allows mutual funds to often become active participants in the courses of actions their investment take. Mutual fund investors, in turn, are somewhat sheltered from the natural chaos of the stock market through diversification. Returns in equity/stock funds are typically higher, if not spectacular. However, it is always advisable to invest in balanced asset allocation fund to earn stable stream of earnings.

During the ongoing era of sky-rocketing oil prices, which led the all times high gold prices and ever escalating dollar against Pak Rupee, the partial investment in these areas also seems lucrative. Till now many investors have gained substantial benefits from forex and commodity markets.

A private investor's foray into various markets is a delicate process, with multiple options and multiple chances for error. Each available market - even those dominated by individual trades/ investors - requires specific information and through comprehension of the market's engine. The prudent investor should always target its return, and then go for diversified investments, be it stock market, bond market, commodity/ foreign currency exchange. Pakistani Capital market has potential to grow, if the decision is being made while considering the rule of "Asset Allocation".