The media has been filled with bad economic news this past year. The headlines repeatedly describe deep trouble in the banking sector, rising energy prices, and a severe decline in the U.S. housing market. These situations have led many investors to question whether they should invest in equities at all. This series will try to shed some light on this question.
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The first installment of this series reviewed the main reasons why some institutions invest in commodities, while the second addressed how they do it. In this final piece, we will review some of the other issues investors have to resolve before investing in this asset class.
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Last month, we reviewed some of the key reasons why so many institutions invest in commodities. They are attracted by their diversification characteristics, by the fact that commodities tend to perform well in high-inflation situations, and by the expectation that they will produce equity-like returns. This month, we will review how these investments are implemented in real life.
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In recent weeks, the rising price of commodities has been abundantly documented by the press. Populations of poor countries are struggling to cover the rising cost of feeding their family. Steel producers are paying hefty price increases to iron ore producers in order to secure supply. Here at home, Canadians are paying ever rising prices to fill their car tank. But commodities have also caught the eye of many institutional investors; this article will identify some of the key reasons of this interest.
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Due to recent action in the financial sector, the subprime crisis has earned the title of the most eventful crisis in decades. The takeover of Bear Stearns by JP Morgan, repeated interventions by the Federal Reserve to address liquidity problems, a run on the bank at the U.K. mortgage lender, Northern Rock, followed by its nationalization, and the freeze of the Canadian non-bank, asset-backed commercial paper (ABCP) market are each rare events. But put together, they become an exception among exceptions. Let’s review four elements that we view as causes of this crisis.
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In the first part of this article, we noted that many organizations have been hit with large losses due to derivative-product disasters. We reviewed some of the basic characteristics of derivative products and highlighted that large corporations and governments make significant use of them. For individuals, vehicles such as principal-protected notes involve derivative products to a large extent. Investors should be sure to understand the risks before investing in vehicles that involve derivative products. We will now see a few more of their characteristics and discuss some of their uses and misuses.
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Last month, a rogue trader at the Société Générale lost $7 billion on unauthorized transactions. In 1995, trader Nick Leeson lost $1.4 billion also on unauthorized transactions, pushing Barings Bank into a collapse. In 1994, Orange County treasurer Robert Citron drew his regional government into financial difficulties with $1.5 billion in trading losses. All of these financial disasters share a common point: they involved the trading of derivative products.
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Last week, we noticed an insightful article in the Benefits Canada magazine (a standard reading for pension executives) by Robin Pond, a partner at the major pension consulting firm Morneau Sobeco.
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On November 9, U.S. financial services company Fannie Mae declared a 3rd quarter loss of $1.4 billion. On November 20, its competitor Freddie Mac declared an even worse $2 billion loss. They also stated that more losses are likely on the way for the 4th quarter. These events opened up a new chapter of the U.S. mortgage crisis.
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Last week, a study released by Fidelity Investments Canada revealed that Canadians, on average, are set to replace only 50% of their working income at retirement. While our readers may have different views on whether this represents a sufficient retirement income, the study brings us back to a basic fact: saving and investing for retirement is an act of managing not only assets, but also liabilities.
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Last week, parity between the Canadian and U.S. currencies has drawn a lot of attention. We prefer to spare our readers from an additional analysis of how and why it happened*, but we will share a few things we learned from years in the financial markets.
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On August 9, the subprime mortgage crisis intensified when BNP Paribas froze refunds on three of its asset-backed securities funds. What happened? While we can’t review all aspects of the situation, we can briefly answer five key questions.
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Infrastructure investing is not a new topic for the Economic Pulse. In a previous edition (“Infrastructures: The Four Ingredients of Success”, April 2006), we reviewed the reasons for pension fund interest in this asset class and the key factors driving investment success. One factor worth mentioning is “cash flow capturing”. For example, institutions such as OMERS and Caisse de Dépôt typically take these assets private instead of passively buying shares in the public market. By controlling entities completely, they can direct them to pay out all their operating profits, therefore capturing the assets’ cash flow. This strategy has two advantages. It provides these institutions with the income they need to cover pension payments. It also removes the earnings from the hands of corporate managers, avoiding the risk of unprofitable reinvestments.
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Principal-protected notes (PPNs) are very popular investment vehicles. According to the Globe and Mail, their issue total is about $14 billion. The very first PPN we recall was launched in 1993 by the National Bank of Canada under the French name “Sécuribourse”, referring to its combination of safety and stock market upside. Not surprisingly, this PPN was launched at a time when Treasury Bill rates reached a multi-decade low of 3%. Clearly, risk-averse investors were looking for an alternative to the wimpy interest rate offered by certificates of deposit.