Managing Equity Investments during Market Downturns - FDC

Proshare

Friday, May 13, 2016 09:50PM / FDC

In this time of economic slowdown investors may be asking them-selves if they have the appetite to stay in the market. Periods of recession or economic downturn are rife with uncertainty, dampened appetite for investments and heightened risk. The natural response in such periods may be to delay investing until conditions improve. In extreme cases, investors may pull out of the markets all together.

The financial crisis/global recession in 2008 left a bad taste in the mouth of investors. Some vowed never to return to the stock market while others reduced their participation to the barest mini-mum. The Nigerian stock market was not exempt. Between 2008 and 2009, investors witnessed significant erosion in the value of their investments as the market lost N7.24trn from a high of N12.64trn.2 This saw reduced participation in the stock market for both foreign and domestic investors.  

As the current economic slowdown shows its ugly head, investors will be less likely to make the same mistakes as those made in 2008/2009. As the old saying goes: once bitten twice shy. Investors are likely to remain on the sidelines until there is some semi-blance of recovery. While accepting that this approach (which is purely risk averse) is understandable, there are approaches to investing that can be used when transacting in the stock market especially during downturns. Most importantly, investors must respond strategically rather than react to market developments in periods of slowdown. With a bit of pro-activity and flexibility, investors can still participate in the market, despite the economic downturn.  

Here are a few ways on how to stay invested:

·         Take advantage of lower stock prices to increase their holdings especially if they have a long term outlook. By purchasing ad-ditional stocks, investors also reduce their average unit cost of purchase. Another good strategy is identifying oversold stocks to purchase (i.e buying into a stock that has seen a lot of selling and is ripe for a turnaround).

·         Invest in dividend paying companies with consistent paying policy or defensive stocks with good dividend history.

·         Manage losses – Markets exaggerate themselves in the direction of losses. Therefore losses have to be minimized. This can be done by setting and adhering to price limits. Stop loss orders, usually executed by brokers, are designed to limit investors’ loss on a position in a security. With a stop loss order, a market order to sell is triggered when the stock trades below a certain price and it will be sold at the next available price.

·         Be ambivalent about bear markets – adopt the right mental approach, knowing there are opportunities also in Bear markets.

·         Diversify across asset classes and investment types to reduce risk. Having a percentage of your portfolio spread amongst stocks, bonds, cash and alternative assets such as real estate assets, is the core of diversification. A proper asset allocation strategy will allow you avoid the potentially negative effects resulting from placing all your eggs in one basket.

·         Invest in assets that help preserve capital.

·         Avoid increasing your borrowing especially to invest in the stock market. This is clearly not a time to increase leverage.

·         Consider Inverse ETFs. Investing in ETFs is similar to using a combination of advanced investment strategies to profit from declining prices. Even though these are instruments which are not available in the Nigerian investment space, they are read-ily available in developed markets.  

·         Play safe. Playing safe means putting a larger portion of your portfolio in money market securities such as fixed deposits, treasury bills and other instruments with shorter maturities and acceptable yields 

Investment strategies have to be dynamic. Different strategies should be adopted in periods of boom and bust. The best advice one can give during a recession is to take the time to revisit long-term goals, and adjust overall asset allocation to protect assets.

It is important to note that in spite of all the strategies out there, nothing is entirely foolproof. It is expected that investors proceed with caution and also seek the services of professionals who would offer guidance.

Economic Investments from a Different Lens: The Advantages of Investing in Trust 

The current economic slump plaguing Nigeria has led to a debate: what measures Nigeria should have taken to better equip the economy against these negative shocks? Economists have long come up with theories to help facilitate sustainable long run growth. There is the neoclassical model of growth,4 which stresses physical capital investment through savings (as savings are a medium for investment funding), a reduction in population growth, and technological progress. Then there is the endogenous growth model, which stresses accumulating human capital - a knowledge-able and productive workforce - through education and grants for research and development.5 The expectation is this investment leads to innovation, which moves the economy forward; as a few entities gain knowledge in a particular sector, all others in the sector are able to partake in this process through knowledge transfer and imitation.6 These theories have helped shape policies in many countries. However, they come with their own draw-backs. These drawbacks include the inability of these models to fully explain growth movements in country samples. The neoclassical model indirectly argues that long-run growth movements are outside the control of Nigerian policymakers and are hence sub-ject to external factors, these factors being elements that drive technological change. Endogenous growth models do not acknowledge the catch-up factor that is observed in the world today where less developed countries like China have higher growth rates than that of more developed countries like the US.

For these reasons there is cause to look at another method through which sustainable economic growth can ensue- social capital.7 Social capital can best be described as the civic norms and engagement as well as the trust culture, which bring about both economic and political progress.8 In many empirical studies, trust is often used as the major proxy for social capital. Political scientist Francis Fukuyama argues that: 

 

“….. one of the most important lessons we can learn from an examination of economic life is that a nation’s well-being, as well as its ability to compete, is conditioned by a single, pervasive cultural characteristic: the level of trust inherent in the society.” 

Trust can be defined as the belief that others will not deliberately or knowingly do us harm if they can avoid it, and will look after our interests, if it is possible.10 Putnam describes trust, as well as other forms of social capital, as a means to solve the dilemmas of collec-tive action and cooperation, which is necessary for economic and po-litical progress. He argues that the reason why nations are seem-ingly backward is not due to ignorance or irrationality, as to the benefit of cooperation facilitating economic growth, but rather due to a lack of trust; individual entities are afraid that once they stake their investments as a contribution to collective action, other parties involved would default on responsibilities.11 Fostering social capital in an economy has the effect of reducing transaction costs such as cost of monitoring, which impede on the ability for businesses to take shape and thrive, which in turn feeds into the macro economy. Robert Putnam argues that trust, which is a form of contract, begets collective action, which helps the society progress politically, eco-nomically, and socially. 

Italy, in the 1950’s, was a natural experiment highlighting the bene-fits of trust. In northern Italy, where there was more trust, Putnam was able to establish a correlation between collective action and eco-nomic progress. Hence, there was more development and greater income was earned when compared to southern Italy, Merzzogiorno,

which had very little trust to guide public and private relation-ships. This was due to the kind of institutions imbibed in the re-gion. Fractionalization in the form of trade restrictions, as well as a surge in mafia and brigandage units wrecking havoc through violence and corruption, fed into the way the citizens of Merzzog-iorno formed their trust expectations.  

Just as was the case in southern Italy, Nigeria has a significant trust deficit driven by a highly fractured ethno-linguistic popula-tion profile. In a 1997 cross-country study of market economies, Knack and Keefer recorded an extremely low percentage of re-spondents who said, "most people can be trusted" in Nigeria.13 This means roughly 78% of the population is distrustful. Now, given Nigeria’s present condition following a decline in oil prices (and hence oil revenue), a weakened naira, and a decline in for-eign exchange reserves, policy makers are looking for ways to encourage collective action and kick start the economy with in-creased business activities. However, in a society where there is a lack of trust from the individual unit to the government and insti-tutional units, this is close to impossible. 

Given the various positives that trust introduces to economies, such as: reductions in transaction costs, innovation, physical and human capital accumulation, and higher returns to both physical and human capital, policy in Nigeria should be constructed in such a way that a trusting culture is developed.14 Hence, in the sphere of governance, state and federal governments should strive to be increasingly transparent with their policies as well as communi-cate effectively what these policies entail to the masses. This would foster a trusting relationship between government and the citizens of Nigeria. More programs like the National Youth Service Corps (NYSC), which ultimately strive to break down barriers of culture and religion, in order to foster tolerance amongst the youths, should also be encouraged as this ultimately builds trust. 

Investing in outreach programs to enable indigenes of Nigeria to better understand one another could be another step towards un-derstanding and tolerance. Encouraging a significant portion of the ethnic groups in Nigeria to engage in and take certain seats in government and public sector institutions would help pacify dis-dain towards certain tribes that consistently hold power, thereby fostering trust in government and institutions. The current gov-ernment is more focused on its anti-corruption war and hence can be rather myopic when it comes to certain theories and policies. Taking social capital accumulation as a matter of precedence is unlikely to occur in the short term or even the medium term but it would be well worth the investment.

 

CLICK HERE TO DOWNLOAD FULL REPORT

 

Related News
SCROLL TO TOP