Risk and reward go hand in hand in investing. Sure, the more risk you take, the more volatile your portfolio's performance will be. But history and theory also tell us that gambles pay off in the long run, giving daredevils bigger returns than scaredy-cats who stick to safer assets. Just look at the figures: the Russell 2000, an index of small US stocks, has gained an average of 9.58 per cent a year since 1982. That is better than the stocks of large companies in the US and Europe, and far better than corporate bonds, which have long-term returns of about four per cent.
It may sound surprising at first that grandma's "slow and steady wins the race" motto does not apply to investing, but it makes sense: investors ought to be rewarded in the long term for buying riskier assets. If there were no "risk premium", there would be little point in buying these assets. And yet people do buy them - lots of them. As investors across the globe have been reminded recently, taking risks does come with downsides. The global credit crunch and the US subprime housing crisis have pummeled stock markets and led many once-bullish investors to rethink their attitudes towards assets with long odds. Prices for US Treasuries have skyrocketed recently, pushing yields down as investors piled into the world's safest assets. A survey this month of high-net-worth investors conducted by Barclays Wealth and the Economist Intelligence Unit (EIU) found that 61 per cent of Australian investors and 51 per cent of Americans said they would sell some assets and convert to cash in a period of economic volatility such as the one under way.
That is a surprising statistic. When more than half of investors say they will move into cash, not content even with the safety of short-term corporate bonds or government debt, fear is unquestionably in the air. And while the Barclays/EIU survey can easily be pigeonholed as a commercially driven effort to put the bank's name in the press and get a read on its target clientele, it does tell a disturbing story about investor behaviour that people in the UAE might want to listen to.
That is because just as the financial crisis is striking fear into the hearts of investors in the West, their peers in the UAE are prepared to take a few risks. Among the 15 countries the Barclays survey included, the UAE ranked first on all the big "are you taking risks" questions. When asked whether they would increase the level of risk-taking in their portfolios during a period of volatility, a stunning 43 per cent of respondents from the UAE said yes. And when asked whether they would be likely to switch fund managers and change investing strategies when volatility hits, 48 per cent from the UAE said they would.
If it is true that taking risks brings returns, you might think this bodes well for UAE investors. To some extent, that is correct: if investors in the UAE continue to take risks and put their money into stocks as they decline in price, historically they have a good chance of coming out on top. "Value" investing, a discipline that seeks cheap deals in stocks and other assets, has outperformed other investment strategies in developed markets over long stretches of time, suggesting that the simple pursuit of cheapness has merit as an investment strategy. The Standard & Poor's 500 has returned roughly nine per cent per year during the past 30-odd years, but the cheap stocks in the index gave a return closer to 10 per cent a year. That might seem like a small difference, but spread over 30 years, it is huge. Investing Dh10,000 with nine per cent returns gives you about Dh133,000 after 30 years. At 10 per cent, you end up with close to Dh175,000.
But taking risks can also go too far when it veers into speculation, a form of gambling in which the bonds between risk and reward dissolve. In this respect, the finding that nearly half of high-net-worth investors in the UAE would likely switch investing strategies during a volatile period is a bit concerning. The full fruits of risky behaviour can be realised only when investors stick to their guns over a long time. If you toy with your investments, diving after every fad and bailing out at the first sign of trouble, you will never stay in long enough for the risk you are taking to be rewarded.
If, for example, you invested in US stocks in December of 1972, you might have thought you had made a bad move and pulled out two years later, by which time the Dow Jones Industrial Average had declined 40 per cent. If you had stayed in for 20 years, though, your original investment would have almost quadrupled in value, despite your initial losses. It also does not hurt to remember that although they may seem to drag on for ages, downturns in stock markets do not last long. In the US, the previous two stock market corrections lasted between four and 19 months. Investors can easily miss part of the recovery if they keep fiddling with their portfolio. And adding to the pitfalls of a quick trigger finger, the more changes that are made to a portfolio's allocations and investments, the more trading fees there are, which eat into the returns.
The moral: the best bet is to stay put, which many investors in the UAE apparently are not doing. Lest we indict the country's investors too quickly, though, it is important to bear in mind that people in the markets here also face a unique set of challenges that encourage riskier than usual investing. First, rising oil revenues have injected a lot of cash into the country's financial system and investors have plenty of spare money to deploy. Second, inflation is rife - it stood at 11.1 per cent last year, according to official figures - and investors are compelled to take on more risk if they are to get inflation-beating returns.
These forces, I suspect, largely explain the results of the Barclays survey. It isn't that investors here are risk-aholics by nature; rather, it is that the UAE's out-of-whack economy has made risky investing almost necessary. Yet despite all the evidence of risky investing behaviour divulged in the Barclays survey, one statistic stood out as proof that the UAE's investing class is getting a little less risk-happy. While property has been a popular destination for the spare cash of UAE investors in previous years, the appetite for these hard assets has apparently died down in a big way. Asked whether they would increase their allocation to property in the next year, only 36 per cent of wealthy UAE investors said they would. A greater proportion of investors from Singapore, India, China and even the US said they would put more money into property investments.
Investors in the UK, meanwhile, might want to borrow a lesson or two from the UAE. The UK emerged in the Barclays survey as the most conservative nation sampled, where investors were among the least likely to increase risk-taking and came in last on the property investment question. But perhaps that is not too surprising. Amid the global financial turmoil, home prices in that country fell 1.2 per cent in June, and have shed more than three per cent in the past year. @afitch@thenational.ae