Lack of faith exacts its negative toll

The turmoil in the global markets hit all three indices with the Aggressive index – and its exposure to riskier plays – suffering the biggest fall as the crisis of confidence continues to widen.

As the tumultuous past few weeks have demonstrated, perhaps more than anything else, what is lacking most in global markets may not simply be credit but that intangible quantity – confidence.

With the London Interbank Offered Rate (Libor) jumping to 6.88% last week – an historical high – after the failure of the American government’s proposed bail-out plan the unease in the banking community has become palpable.

Robert Jenkins, the chairman of F&C Asset Management and of the Investment Management Association, said at a recent Financial Services Authority conference that there is “no shortage of liquidity, there is only a shortage of confidence”.

The confidence crisis has led to an increasingly sensitive marketplace where widespread stock selling occurs at the mere hint of negative news. This has driven share prices downwards, with the FTSE 100 index falling by more than 22% since September 2007.

The asset management industry has not escaped the problem posting record outflows of funds in the first few months of 2008 as funds with equity exposure tracked falls in global markets. Even equity income did not provide solace for nervy investors as default risk crept upwards and poor earnings forecasts presented the inevitability of dividend cuts.

In the wake of this the Adviser Fund Index portfolios have suffered, with the Cautious index losing 12.9%, the Balanced 15.8% and the Aggressive suffering a fall of 19.3%. The falls have prompted fears that investor sentiment to risk is in danger of being altered in the long-term as they struggle to stomach the hefty losses and the continuing uncertainty about when markets will begin their recovery.

Tim Cockerill, the head of research at Rowan, says he is convinced that a sea-change in sentiment has already started.

“Absolutely, I think definitely if you look at it from a private client point of view [the change of sentiment] will happen,” he says. “When you are in a position of having made some quite hefty losses your whole perception of risk can change.”

As shown by the AFI portfolios, active managed funds operating in higher risk areas like emerging market equities or commodities have taken the biggest hit as money flowed into defensive assets.

Although a greater degree of volatility was to be expected in these types of products, nonetheless the scale of the collapse has sent shockwaves across the industry. In this climate, says Cockerill, investors may even be looking to switch entirely out of risky asset classes.

“Any investor who does their homework in pure capital terms there’s a strong case for questioning why one would want to have invested in the equity market over the past 10 years,” he says.

While falling stock prices may have unnerved investors, a new and more worrying threat to deposits emerged with the collapse of Lehman Brothers.

The Federal Reserve’s decision to allow the firm’s collapse dispelled the “too big to fail” argument, which had underpinned many investors’ confidence in struggling financial institutions.

The move was followed by the sales of HBOS and Merrill Lynch as well as the part-nationalisation of Bradford & Bingley suggesting the impact of the crisis on the ability of banks to finance themselves was worse than initially thought.

The situation was felt serious enough to prompt the Irish government to guarantee the deposits and borrowings of six of the country’s major lenders last week, accounting for liabilities of up to €400 billion (£317 billion).

Jonathan Wallis, the head of retail fund research at Allenbridge Group, says given current market conditions it is not the right time for people to be selling out of their investments.

“I certainly wouldn’t advise people to bail out now,” he says. “Obviously the market is off significantly so its time for investors to take a longer-term view.”

Despite his warnings Wallis says it is inevitable that some people will start switching out of high-risk funds into more defensive investments but, he says, it is “probably the wrong thing to do”.

His sentiments are supported by Mark Dampier, the head of research at Hargreaves Lansdown, who says investors should not be overly concerned by stockmarket volatility over the short term.

“In valuation terms [the FTSE 100] is getting to quite good value,” Dampier says. “If you get to 4200 you’re crossing the guilt yield and when you get to 4000 you are crossing cash.”

Inconsistency by central banks and politicians, however, continues to stoke concerns about the ability of Britain and America to dig their way out of the crisis. While earlier in the decade the bursting of the tech bubble battered stockmarkets the threat of contagion to other sectors was limited.

The banking system, however, lies at the centre of the capitalist economic model and as such poses far greater systemic risk to the British and American economies.

Cockerill says quantitative stock analysis may well come undone even after markets have bottomed. “I think you have to forget share price history because what created that price will not be there in the future,” he says.

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/adviser_fund_index.html).