Protection in Volatile Times

The last few months have certainly been tough for investors. What started as uncertainty in the markets turned bloodshed when the near collapse of a couple of major investment banks and AIG who underwrite many of the financial derivatives brought about the realisation of just how intertwined global credit, financial institutions and investment markets really are.

As a result, what started as uncertainty surrounding financial institutions became uncertainty around the economy as a whole. Governments have since injected huge cash sums and cut interest rates in an effort to ensure that the financial backbones of their economies do not fall.

This should provide comfort to investors. The fact that the major financial economies are willing to dig deep and coordinate their efforts in an attempt to minimise the impact of what is really a global credit restructure means that we are already taking steps towards recovery.

Having seen many of the equity markets fall by half their value, investors are naturally reticent about further investment into sharemarkets. This month considers the psychology of our investment decisions and whether we are doomed to make the same mistakes?

Looking for certainty

I have recently spent a lot of time looking at the whole area of structured products and in particular, those offering capital protection. My initial thoughts were that since the ASX 200 has just fallen by over 40% over the last 12 months (to the end of October), why would you look for capital protection? Surely the time for protection is when the market is high? Yet investors can’t seem to get enough of these products, so it must be fulfilling a basic need for us?

On face value it seems odd that the hardest time to sell capital protection is in the middle of a bull run, yet we can’t seem to get enough of them when the markets have fallen.

However, it’s the certainty we require in uncertain times that capital protected products are able to provide that make them an attractive proposition, allowing us to invest in a discounted market when we would normally find ourselves sitting on the sidelines watching the window of opportunity pass us by, too cautious to dip our toe in the market.

This issue looks at the whole raft of capital protected products that have flooded the market, how to distinguish between them, some of the potential pitfalls and whether they can add any value if the market has bottomed out already?