Back to basics

We are just now feeling the effects of the global downturn of financial markets. The situation is unprecedented and nobody really knows how soon or how long the recovery will take. More importantly, nobody knows how the financial markets will look like after the dust settles. The only fact we can be sure of is that investment banking will no longer wield the financial clout it used to have. Most players in the industry will have probably de-leveraged and be more strongly capitalized. We will have more stable financial institutions. Unfortunately, this could also mean less velocity of money and less credit being made available even to qualified borrowers. The bottom line is we must all be more conservative and assume that our own economic prospects may not yet be as bright the coming year. These times call for belt tightening and aggressive pursuit of new income generating activities. These times also call for making sure that investments and loans are made only when the right fundamentals are there. When you invest, make sure you know what return to expect, how much risk is involved in the investment and how long you must be prepared to keep your money invested. When you are borrowing, you must also make sure that your use of the funds will generate income sufficient to pay for the loan interest and principal. If your loan is of an emergency character, you must still make sure that you have cash flow from other sources that can pay for loan. Temporarily spared The Philippines, at least in the world of finance and investments infrastructure may be considered a “backward” country. Because of this, we were “by-passed” in most of the sub-prime and other creative investments that the big global investment bankers and other financial institutions like Bear Stearns, Fannie Mae, Freddie Mac, Lehman Bros., AIG, etc. concocted. We are a “borrower country” and happily we were spared of the direct hit of the debacles caused by sub-prime problem. Sadly, this blessing could be temporary. If some institutions in the U.S. and Europe were not hit directly, these will nevertheless suffer losses sooner or later because of the “domino effect.” Banks all have business relations with each other. The smaller banks will eventually be affected by the failure of the bigger ones. The Philippine economy, as well, is tied up to most of these financial institutions and particularly to the U.S. economy. As we hear time and again, “When the United States catches a cold, the Philippines catches pneumonia.” Thus, we need to be prepared. Less credit available To ensure their stability, banks will be very careful about the loans they give out. Banks need to make all their assets earn in order to be profitable and stable. When loans that have been granted by the bank are unpaid, the banks’ assets become non-performing and thus non-earning. Clearly, banks cannot afford to have further non-earning assets*. Thus, while the collateral for loans will be a major requirement by banks, each borrower’s capacity to pay will be more important.

* Note that high levels of non-performing loan accounts hit our banking industry in the recent years. In fact because of the alarming rate of loan defaults, our government created the SPAV law which allowed banks which sell their non-performing assets to amortize their losses on such sales over a deferred period of some five or 10 years. This effectively ‘saved” our banking industry from possible collapse as the troubled banks did not have to book their losses at one time. They were effectively given new leases in life as they did not have to immediately raise massive new equity funds to maintain their capital adequacy ratios.

Companies and individuals grow their assets through prudent borrowings. Through this kind of leverage, they effectively increase their investible funds. In this way, their growth is not limited only to their real capital. With less credit available, the growth of industry and the entire economy will be dampened. There is much construction ongoing especially for housing units targeted for the OFWs and the retirement communities. The sale of these units was premised on the availability of loans based on sustained valuation of the real estate assets. Without those loans, it will be more difficult to dispose of the units. Where to invest now In the midst of these difficulties, the concerns of most savers are where to invest what is being saved now? The answer is really quite obvious. First be clear on what your purpose is in investing. Your purpose will automatically define your financial goals in terms of the three basic parameters, namely: a) how much return to expect; b) what level of risk can be assumed and c) how much time should the investment be kept. In all cases, given today’s uncertainties, capital preservation will most likely be the overriding consideration in most investments. This means that avoiding losses is the number one criterion in choosing the investment. Short term vs long term Time is the greatest mitigator of risk. The longer the investment period, the lower the risk and the higher the potential return. As an investor generally is not able to control the actual returns of an investment, it is best to have time manage the risks. This is why for long-term investors, it is very important that they leave their money alone once they have invested it. Allow the investment to compound over time, preferably five (5) years, to weather the economic fluctuations and thus stabilize investment returns. For retirees whose need for funds is fairly short to medium term, the way to go is Government securities and fundamentally sound corporate bond issues. Here the end game is regularity of income and safety of capital. One could also consider solid income earning real estate properties as a good hedge against inflation and volatility of the financial markets. And finally, when investing, spread the risks through diversification. As they say, don’t put all your eggs in one basket. Strategic asset allocation is one other powerful tool that manages risks and stabilizes earnings. There is hope and opportunity But in spite of all these, we should not lose hope. A most important principle, in the investment markets, “What goes down will eventually go up again.” It is a matter of having the strength and courage to weather this storm. In purely financial terms, if you have investible funds, you must continue to invest regularly. This way you average your cost and stand to achieve much better returns in the future when markets will have stabilized. Market valuation today is at an all time low. Share prices of triple A companies do not do justice to their real worth. This is bound to correct itself sooner or later. This is really the time to invest in these solid companies. Comments on the US dollar Where goes the US Dollar (USD)? It’s strengthening in the midst of the current global financial crisis. Will it last? To be sure, the USD is still the currency of choice for international trade. Over 60% of the world’s currency is still the USD. Reserves of most countries are still in USD. These facts leave the world very little choice but to keep the USD. In fact, experts estimate that it will take about a decade to replace the USD as the international currency, assuming the world collectively decide to do so. In addition to this reality, there could be three more reasons why the USD will remain strong, at least for the medium term. More interest rate cuts ? European and other governments have come to realize the need to stimulate growth in their own economies. For too long they kept their interest rates high hoping that they could decouple their respective economies from that of the US. Well that was proven wrong and now it’s catch up time for them. Growth is now their first priority and that means they have to narrow the interest gap with US interest rates. We can therefore expect further interest rates cuts by these foreign governments in the coming months. Massive deleveraging Mark Astley, CEO of Millennium Global Investments, a U.K.-based currency manager notes, "there is a pyramid of leverage in the financial markets that will take considerable time to unwind. The half-frozen credit markets are only slowing down the process. As they thaw out completely, expect hedge funds and foreign banks to keep buying up dollars”.?? Fear and uncertainty The condition of fear and uncertainty is not expected to abate for some time. For as long it holds, people will shy away from any risks. Thus we saw the flight to the USD since the subprime crisis began to boil. In a recent research UniCredit noted.” We do not expect global recession fears to wane considerably." Today, even after the US elections, uncertainty reigns in the capital markets. Idle funds continue to seek the USD, which is perceived to be the safe haven of currencies. As history shows, during times of fear and risk aversion, the dollar tends to outperform all others. The more critical issue is how long can the USD sustain its strength? For now, the best intelligent “guess” is at least for the most part of 2009. Please email info@colaycofoundation.com if you have any questions or comments. SEASON’S GREETINGS We can turn adversity into prosperity. It is a matter of attitude and perspective. I’d like to take this opportunity to greet all of you a Blessed Christmas and a Happy and Prosperous 2009. FRANCISCO J. COLAYCO is an entrepreneur, a venture developer and financial advisor. He has over 40 years of experience that covers service contracting in the Middle East, manufacturing, trading construction, shipbuilding, management consulting, banking and financial services. He is the Chairman of the Colayco Foundation for Education (CFE), a prime mover of the financial literacy movement. He joins our website blog to share with ordinary income earners, Overseas Filipino Workers (OFW) and students the simple principles to "Save what you earn and grow what you save." For questions, you may email Mr. Colayco at info@colaycofoundation.com or text +63917-8537333. CFE is the publisher of Mr. Colayco's bestsellers: Wealth Within Your Reach (2004 National Book Award for Business and Economics), Making Your Money Work (Nominated in 2005, National Book Awards Business and Economics), Pera Palaguin Workbook and Money for Kids. The books are available at National Bookstore, Powerbooks, Fully Booked, Pandayan or directly from CFE. CFE is also the producer of the PISOBILITIES DVD series, available at all SM record bars, National Bookstore, Odyssey, Astrovision, Astroplus and other major audio-video stores nationwide. CFE also conducts personal finance management talks, seminars, and workshops. For more information on CFE programs, visit www.colaycofoundation.com or call (632) 637-3731 or 637-3741.