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Investing in Turbulent Times

By James J. Green

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The housing crisis and credit market upheaval that began last year have been creating a roller coaster ride for market participants with equity markets down across the globe by 30% or more in the last year. During times like these, emotions can overwhelm sound decision-making as investors panic and flee to the exits.

The entire credit market is frozen as market anxiety has reached alarming levels which is resulting in significant government intervention. This abnormal credit cycle has been exaggerated due to lax underwriting standards for residential mortgage loans and other debt and by the heavy use of securitization over the last few years.

Ironically, this market also leads us to believe that there are now excellent opportunities in the markets for investors that can remain disciplined and take the longer-term view necessary to see beyond the current economic problems.

I wish I had some eye-opening quick fixes for advisors, but frankly that’s exactly what got Wall Street into this crisis. We believe that turbulent times in the market are the most important times to stick with disciplined, conservative investment principles that have worked well over numerous market cycles.

This conservative approach to investment led us to be more defensive as credit standards deteriorated in 2005 and 2006 and kept us out of the new structured debt products that were proliferating on Wall Street. By similarly following the basics, investors can position their portfolios to outperform when the fear in the markets ultimately subsides. The flip side of volatility is opportunity for patient investors who are focused on finding undervalued assets with good growth prospects that the market will recognize in the next three to five years.

This investment philosophy grew out of managing pension assets for the last three decades during a number of market cycles. We have also been focused on finding value opportunities. Value has historically outperformed growth over the market cycle and provided downside protection, as we are seeing so far this year.

Since equity markets are near their average pullback in past recessions, we believe that the fundamental trend of rising equity markets across market cycles will pull markets upwards over three to five years back to their long-term trend line, once it becomes clear that the negative effects of the housing and credit bubbles are diminishing. We are looking for opportunities in the financial sector that have good balance sheets and in other distressed areas where market psychology has most impacted valuations.

For qualified investors with less need for liquidity, we also believe that now is an excellent time to increase exposure to private equity funds. Private equity funds have a record amount of uncommitted capital and the well-established private equity funds have the skills and industry contacts necessary to identify and acquire significantly undervalued assets.

With their current dry powder, we expect that the private equity funds that are good at improving operations and have not historically relied on too much leverage to generate results will be viewed as one of the big winners from the current turbulent times.

While it may be difficult to focus beyond the latest headlines of bailouts and bank failures, with a prudent and patient approach, we believe that investors will look back at this time as one of the rare buying opportunities of a lifetime–one that their advisors can help them take full advantage of.

Wyatt Crumpler VP of Trust Investments American Beacon Advisors, Inc. Fort Worth, Texas

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