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Time to play in Russia

Mar 10, 2014

Algoam has monitored what happens when one chases risk during and in the aftermath of a crisis. There are many types of events that increase uncertainty. Historical examples are:

  • The recent crisis in the Eurozone and the impact on stocks and bonds yields in Portugal, Spain, Greece, Ireland, France, Italy.
  • The Japanese Nuclear disaster in Fukushima and its impact on Japanese equities and the JPY.
  • The Turkish Lira crisis in 2001 and its impact on interest rates, equities.
  • Impact on the shares of BP from the Deepwater Horizon, the largest man made disaster in the history of the petroleum industry.
  • Following the Asian currency crisis, the Russian debt default of 1998 and its impact on Emerging Markets equities as well as the Ruble.
  • Mexican Peso crisis of 1982.

The latest is the mini crisis in Ukraine and the repercussions on Russian equities and currency. Even a minor crisis such as this one can get blown out of proportion depending on what else is going on in the global markets. The impact of a small stone in calm waters can appear to be disturbing as both politicians and journalists awake from their slumber. Lame presidents and right wing nationalists come to the fore and of course the impact of intervention is more painfully felt when there is no other new news. Everything can be faked. Even the markets may react violently and drop as a knee jerk reaction. It is best to stand back and observe if there is follow through. Genuine crisis don’t last for a couple of days. The events and repercussions take months and sometimes years to unfold and the changes in market prices can be substantial.

It is easy to be distracted by professional money managers, who are likely to end up joining the chorus and come out with the same recommendations when the crisis is severe and be divided when it is not. The starting point is always important. Russian equities and the Ruble for example, have already been poor performers. No one is enchanted with Mr. Putin and his policies and the United States and Russia haven’t exactly been behaving as friends and have been at odds with one another on almost all issues.

Then there are those who say, “Markets are where they are for a reason”. These are usually the less well informed who believe in market efficiency. Markets can become very expensive or very cheap for reasons that are internal and external to the country in question. Markets most certainly are not efficient. Then what is the best way to position oneself?

First and foremost one has to decide how much money to allocate to a given country or currency and then the best way to apply it. In a crisis it doesn’t pay to take a large position, unless you happen to Mr. Buffett and what seems like a large position is actually quite a small part of your portfolio. The point is not get carried away by other people numbers!

Second important point is to continue to buy if markets keep selling off. To keep it simple, one should buy at intermittent periods, say every month. Crisis don’t usually last for very long periods. Like sex or a terminal illness, climax can be rather rapid.

Third, stay in the very liquid portion of the market. Buy big company’s shares and large liquid bonds. The cost of entry and exit is less.

Fourth, don’t then buy for the short hall. Unless you happen to be a really excellent trader, don’t punt.

Fifth, don’t try to double, triple or quadruple your money. Be sensible about what can be extracted out of a crisis. In the long term there is no guarantee that currency and risk adjusted emerging market returns will be significantly higher than developed market returns.

There are always opportunities as well as pitfall when investing. As much as possible try to measure how severe the crisis is in the context of previous episodes and the current overall market environment. Look at the market reactions and then react to the markets, ideally through measurement of what is actually going on, not what you hear on CNBC or Bloomberg.

What we repeatedly find is that chasing risk is often a good idea, as long as one is not overly leveraged, highly risky assets are a small part of the overall portfolio and risk is being measured and monitored systematically and one is prepared to allow the turbulence to work its way through the system.

Last, but not least, staying out or hedging the risks in time of increasing uncertainty is an important option that should be used. We can show that these additional risk mitigating options always improves risk adjusted returns.

Russian assets are cheap, take some position and start to manage them. Seriously, the situation in Russia is probably not as serious as everyone is making it out to be. If it does get more serious, add to the small positions. But then don’t keep on buying. Make your bet and let the the future unfold. Equity markets or currencies are not for the faint hearted or the greedy. You and your portfolio have to remain balanced.

These are our observations. There is no guarantee that you will make money when investing in the financial markets. Crisis situations are even more tricky. Most people who trade excessively lose money in the markets. Look honestly at your personal track record and stay out of markets if it is not good.