While such behaviour is common in share markets, unusually we are seeing a similar pattern in fixed interest markets as the US sub prime mortgage market crisis deepens. The high default rate on certain US mortgages has led to a drop in value of a number of fixed interest products which are exposed to these assets. One such product is a CDO fund. A CDO, or Collateralised Debt Obligation, is created when a bank or other lending institution pools together a number of loans and sells them to another party.

That party securitises them and sells them off to investors in tranches, based on different levels of risk. Because these securities are backed by a portfolio of diversified loans rather than a single loan, the overall risk is lessened. Further enhancements to CDO's mean that they are now quite complex products. It can be hard to quantify the level of risk they carry, especially in a market such as we have now with a high rate of default. It is possible for bad loans to be buried deeply within these structures and for defaults to have ripple effects through linked structures. This has resulted in values falling across the board and these values will not be restored until the fear in the market subsides.

A number of fixed interest funds contain CDO's. Among these are two ING funds - the Diversified Yield Fund and the Regular Income Fund. A rather vocal sharebroker has urged investors in these funds, which he refers to as cash funds, to sell now (at a loss) and put their money in the bank. This is dangerous advice based on a lack of understanding of these products. These funds are far from cash funds and are intended for investors with a minimum three to five year investment time frame, as their value can be affected by market cycles. Selling at a low point in a market cycle is not smart investing and will only result in paper losses becoming real losses.

As market fears subside, values will return to normal and those who have ignored the scaremongers have already seen an improvement in the value of their investment. The ING Funds have only a small exposure to the sub prime mortgage market (between 7% and 9%) and the bulk of the funds are made up of thousands of senior (i.e. low risk) secured bank loans. The portfolios contain a large, diversified mix of assets with an average credit rating of BBB which implies a low chance of default. There have been no credit defaults in the portfolios and therefore the drop in value is driven only by market sentiment.

There are a small number of advisers throughout the country who play on the fears of investors to raise their own profiles and increase the size of their business. They have a set pattern of operating. They pick on a product which they don't sell themselves. When that product suffers a temporary drop in value due to market sentiment, they broadcast messages of doom and gloom to create even more panic and fear. They advise investors to sell at a loss. The blame for that loss is placed with the person who sold the product to the investor, not with the adviser who creates the panic. Investors begin distrusting everyone but the scaremonger (who in fact, is the last person they should trust). This is a clever and manipulative strategy driven by self interest and resulting in many naïve investors suffering pointless losses.

My advice is to be extremely wary of such broadcast advice to sell in fear and to do what seasoned investors do - seek personalised advice from competent advisers, assess the true level of risk and wait for the market to change, as it inevitably will.

Liz Koh

Liz Koh is a financial adviser. A copy of her disclosure statement can be obtained on request and free of charge by calling 0800 273 847.

Ph: 0800 273 847

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

www.moneymax.co.nz

Be first to comment this article

Only registered users can write comments.

Please login or register.