Q&A WITH ALI ALVI

HEAD OF RESEARCH, UBL FUND MANAGERS

Aug 03 - 09, 2009

IS THERE A UNIVERSAL FORMULA FOR SUCCESSFUL INVESTING?

Systematic approach is the key to successful investing. An investor must first identify his / her investment goals, liquidity requirements, and risk tolerance. A systematic investment plan should be devised with the help of a financial advisor on the basis of these factors and it should be followed through his / her lifetime to achieve the goals. As the investment goals and risk tolerance vary from individual to individual, no single investment plan can provide a "fits all sizes" solution. So, the universal formula for successful investing is to follow a systematic approach. However, the execution of the formula will be different for every individual investor.

HOW MUCH INFLUENCE DOES THE STRATEGY YOU ADOPT HAVE ON THE RETURNS A PORTFOLIO GENERATES?

Asset allocation is the most important part of any investment strategy and the returns generated by any strategy have a major dependence on this decision. An investment portfolio concentrated in equities will generate vastly different returns than a portfolio invested in fixed income instruments. The return differential between portfolios with varying asset allocations will become even more apparent over the long-term. Also, different asset allocations will not only lead to varying returns but more importantly the volatility of returns will be very different. An equity-oriented strategy will have volatile returns while a fixed income strategy will typically exhibit stable returns.

The strategic allocations within an asset class (e.g. sectors / stocks selection within equities asset class) only lead to minor differential in overall portfolio's return and this differential is further diluted over the long-term.

YOU TALK ABOUT MAKING "STRATEGIC INVESTMENT DECISIONS", BUT IS IT REALLY POSSIBLE TO PREDICT HOW MARKETS WILL BEHAVE?

It is not possible to predict the exact price of an investment instrument on a particular date in the future with certainty. However, market prices of stocks / bonds etc are driven by demand / supply dynamics as well as the fundamental value of the instrument (e.g. the book value of a stock). Analysis of these factors can help a professional investment manager decide if there is a higher probability of an instrument's market price rising or falling. The impact of demand / supply dynamics is typically short-lived in the market and the market prices of investment instruments tend to converge to their fundamental valuations. Therefore, value investment i.e. the practice of investing in under-valued instruments can help an investor generate higher returns.

TRADITIONALLY, INVESTMENT STRATEGIES HAVE BEEN CLASSIFIED AS CONSERVATIVE OR AGGRESSIVE. IS THIS AN ADEQUATE DISTINCTION?

In my view, it is far from adequate and is subject to other factors such as the investor's age, income level, liquidity requirements, and investment goals. An aggressive strategy for a retired investor might classify as too conservative for a young investor with a stable income and few liabilities. Therefore, it is important to devise a customized investment strategy with the help of an investment advisor to insure that all elements of the strategy work together to help the investor reach his goals while keeping his assets and income under consideration.

WHAT IS THE RISK, AND HOW DO INVESTORS PERCEIVE IT?

"Risk" is a tricky term because the scientific definition does not necessarily match with a typical investor's understanding of the term. In financial sector "Risk" is measured through "Standard Deviation" or "Volatility". In other words, it is the range in which the returns fluctuate. But, from my experience, majority of investors think of "Risk" in terms of the protection of their invested capital. Investors are mainly focused on downside risk; however, financially speaking "Risk" is a symmetric phenomenon. A "Risky" investment can lead to both much higher and much lower returns than expected over a specified period. The symmetric nature of "Risk" means that young investors can afford higher risk because they can afford the longer investment horizon to see their risky investments recover incase of an unfortunate decline in investment value during early part of investment period.

When the equity markets tumbled in 2008, some people thought that diversification had failed. It seemed that all stocks and sectors were heading in the same direction.

It is true that the equity markets had a very tough time in 2008 and almost all sectors declined significantly. The mortgage crisis and fear of economic slowdown forced investors to shun equities asset class as a whole.

However, the idea of diversification is not limited to "diversification within an asset class" but rather to "diversification across asset classes". A portfolio of investments distributed across equities, money market instruments, and gold would have suffered from decline in equities but benefited from capital gains in money market instruments and gold.

THE EARLY PART OF THIS DECADE SAW SIGNIFICANT CUTS IN THE RETURNS OF NATIONAL SAVING SCHEMES. WHAT EFFECT DID THIS HAVE ON WEALTH MANAGEMENT?

In the 1980's and 90's, the returns on national saving schemes were very attractive and came with only the sovereign risk attached. This created a very non-conducive environment for the wealth management industry as investors understandably favored the NSS. However, the decline in NSS returns created a more competitive environment for asset management companies to flourish and the industry size grew from Rs22bn in 2000 to Rs350bn in 2007. Fortunately, the stock market also performed well during this period.

Subsequently, in 2008-09, NSS rates were raised, which once again skewed the playing field against the wealth management industry. However, I believe that the idea of NSS offering high yields at almost no risk goes against the efficient market hypothesis and is not sustainable in the end.

DO CLIENTS THINK IN TERMS OF PERFORMANCE VERSUS BENCHMARKS?

Many clients do not really think in terms of benchmark categories. What they are mainly interested in is whether the value of their portfolio has risen in absolute terms, not whether they have earned more than a comparable stock market index. The recent decline in equity prices in 2008-09 finally made the investors realize the importance of having a defensive strategy in place to limit the losses to less than those of the benchmark. Capital protected funds and principal protected plans launched by UBL Fund Managers have also become more attractive to investors after the recent meltdown.