THE MARKETS Jacques Magliolo
THERE is a saying at the Johannesburg Stock Exchange that there is no skill in buying or selling shares during strong bull or bear markets, but that it takes unprecedented courage to go against mass hysteria and buy when others are selling.
Portfolio managers are being made aware of this daily. Although the market is rapidly starting to look pricey, clients continue to place millions of rands worth of shares in the hands of managers and then hound them to follow basic bull or bear trends.
To make matters worse, the manager has to appease not one but three types of clients. Although the research needed to make informed buy-sell decisions remains the same, these clients have different investment objectives and demand personal attention.
* The first type of investor is the institutional client, who usually places the largest amount of funds with the manager and thus demands the greatest amount of attention. Most institutions insist on having final authority over all buy-sell decisions, and the manager is bound to adhere to these instructions.
Unlike the analyst, who assesses the equity market, the manager has to have a sound knowledge of all market instruments. A client’s instruction could thus include how to spread his investment over equities, mortgage bonds, government bonds and other securities such as debentures, futures, options and preference shares.
* The advantage to the manager of controlling institutional funds is “lots of money for few clients”, says a former portfolio manager. He adds that the second category of investor, the private client, buys shares for five main reasons and each is linked to the level of risk he is willing to accept. It is the manager’s task to assess these risks.
The first type of private client will insist on safety of capital. When approached with such a request, the manager’s observation is that the investor is looking for return with minimal risk and he will suggest government bonds or unit trusts.
An investor could ask for gradual capital appreciation. These are people who buy shares for a specific future purpose, such as their children’s education or for an income after retirement. The time frame is usually more than 10 years and the shares will be kept at any cost, even against the manager’s advice. Under such circumstances, the manager would aim to buy major index stocks, such as South African Breweries, Anglo or Barlow Rand.
The next category of private client is the investor who demands quick capital gains, but who also accepts the possibility of quick financial losses. At the other extreme, managers are also approached by pensioners or widows, who depend on dividend income for their livelihood. Finally, the more astute client normally looks for a compromise between capital gains and dividend payments.
* The third type of client is called a trader. They usually operate on a short-term basis and are a combination of speculators and long-term investors. The main difference is that speculators often buy and sell shares on rumour. The trader will buy shares on merit, but will sell them if they drop below a predetermined level.
There is a common thread which is applied to the various types of clients. All investment decisions involve making a trade-off between the level of risk acceptable to the client and expected returns, since higher risks usually accompany greater returns.
The manager must decide how much additional return is necessary to compensate the client for assuming greater risk. To succeed, the manager must be able to understand and offset the risk variable.
There are two different types of risk — one uncontrollable, the other controllable through technique. The first is called systematic risk and is unavoidable as it is inherent to the market as a whole. Market analysts say it can be reduced, to some extent, by buying a spread of shares, investing in real estate or government bonds and securities.
The second is called unsystematic risk and there are two types. Firstly, there is a risk associated with an individual share and how it reacts to overall market trends. Called project or specific risk, it is the probability that a specific share’s actual return will be less than expected.
The second category is the chance that a group of shares in a particular sector could behave contrary to the overall index. This risk is similar to specific risk except that it entails diversifying across a number of sectors to offset cyclical fluctuations.
Whichever way the manager turns, there is no relief from stress. Not surprisingly, the burnout period for such a job is less than five years.