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Emerging risks

It is difficult not to feel buoyed by the better tone of markets worldwide. Economic data supports the contention that the US is heading for a soft landing, removing the need for further monetary tightening.

At home, the Bank of England is softening its stance on inflationary prospects, leading to speculation that this month’s rise in base rate could mark the peak of the cycle. Little wonder that an appetite for shares is reviving.

Far be it from me to shout “Bah, humbug” at those private investors piling into equity Isas but it seems that a few words of caution are required. The problem with a wave of renewed enthusiasm for investing is that it tends to be indiscriminate. Among the markets gaining support are those in lesser-developed countries which took a hit earlier in the year.

If anything, the outlook for these markets has deteriorated, with the world economy slowing and the emergence of political figures in South America less friendly to capitalist ideals. The risk premium available to investors seeking exposure to these markets has been shrinking. Last week, Bedlam Asset Management drew attention to the narrow spread between yields on government debt from the developed world and that available from the likes of Thailand, South Korea and Venezuela.

Other developments give cause for a strategy rethink. Reaction to the Democrats wresting control of both houses of Congress from the Republicans was limited but change will undoubtedly result. Aside from the apparent shift in the position regarding Iraq, more protectionism in trade could be in prospect. All this highlights the risks that investors seem prepared to ignore for the time being. These risks are at their greatest in the more volatile areas of markets, such as smaller companies and developing countries, and also seem greater for bonds than equities.

The return of the private investor to the market was exemplified at the Association of Investment Companies’ roadshow at Sandown Park. Many exhibitors ran out of literature and Close Investments’ collapsible frisbees were in such demand that those hoping to impress their friends with this latest must-have toy were disappointed.

One demanding question related to the debate over whether indexation or active management is best. Reference was made to studies conducted by Dimson and Marsh of the London Business School. For those unfamiliar with their findings, it would seem that luck appears the most likely reason for outperformance. My response was that I was always happy to back lucky managers.

The somewhat unpalatable truth is that the dice are loaded against the manager as benchmarks are devoid of cost. Given that the market creates a zero-sum world in which to operate, it follows that more will fail to beat the average than those who deliver superior performance, since costs are a tax on performance. Is Anthony Bolton merely lucky? These are thoughts worthy of further debate.

Brian Tora ( is principal of the Tora Partnership


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