The entire discipline of finance centres on the concept of risk. Without risk, you forgo any opportunity to take reward, or a premium, on your investment. If you were to invest in cash for instance (the closest you can get to a risk-free asset) you simply secure the minimum return (presently anywhere between 4.5 and 6.5 per cent). The question is, when do you take on more risk? The answer essentially lies in your personality and how much you need a high return. The overall economic environment also plays a big role - as I will explain...
To say the current economic environment (both domestically and internationally) is challenging at present is quite an understatement. The world's major economic powerhouses are undergoing critical financial surgery and there are no guarantees any of them will emerge in a state worthy of holding their current rankings on the world stage. It's made investing, especially in companies exposed to offshore machinations, very challenging.
If you were, for instance, to hold the view that China was going to be an on-going source of supreme economic growth well into the next decade, you might invest heavily in Australian miners. The risk you take though is that commodities prices tumble as China pulls investment back from Australia as Europe puts a big dent in its GDP. Is that likely? Who's to say at this point? It's certainly a possibility. Then there's the US. Its debt position is clearly unsustainable. Do you obtain exposure to US growth now and hope the bond vigilantes don't grab hold of the US treasury market? They are tough decisions.
One thing you can be a little surer of is that, generally speaking, many in the market are aware that the future is both unclear and uncertain. Volumes on the share market alone are indicative of that - many investors are simply just 'sitting on the sidelines'.
So while there's increased risk in the market, and no doubt much money to be made, in many cases those risks are too abstract and murky to calculate properly and then make an informed decision around. In fact rather than looking at the risks, a lot of investors are simply looking at the return side of the equation and making investment decisions that way. I recently spoke with a senior equities strategist at a leading investment house in Sydney. He said the firm's strategy was now a conservative one - investing in cash and the more predictable emerging markets. He said 'playing it safe' at the moment was the only real option. David Murray's Future Fund (the fund that guarantee's the superannuation of government sector workers) is working a similar strategy.
The risks have increased in recent times, and even though that may mean super-normal returns are hiding in dark corners, many know all-too-well the pain of being burned and have decided that the best offense is a good defence. Even those with a healthy appetite for risk now know it's not always wise to indulge.
David Taylor
