News & Commentary

How fixed interest can help the fear factor 26 May 10

What price do you put on fear?

Clearly investors - both professional and individual - have been spooked by the Eurozone debt concerns and uncertainty that the bailout packages have not steadied European government bond markets.

The VIX or volatility index is traded on the Chicago Board Options Exchange and it provides an interesting measure of market sentiment because it shows the price investors are willing to pay to insure themselves against severe market moves.

Sometimes referred to as the 'fear index' at the height of the global financial crisis the VIX hit a high of 80 and then declined relatively steadily as markets returned to normal trading patterns. The VIX has spent the early part of 2010 trading below 20.

But in April and May the tremors through the bond market saw the VIX climb sharply and last week went above 40 - its highest level for more than a year.

It is hardly surprising that the Eurozone credit issues are unnerving markets - and in particular short-term investors. The global financial crisis meant huge fiscal deficits were run up to stimulate economies to avoid the risk of depression. But sooner or later markets were bound to turn their attention to the fact that the fiscal deficits had to be paid back - not to mention financed in the short-term.

Compound the international concerns with our local political issues over the super profit tax on mining companies and suddenly the Australian dollar and our economy doesn''t feel quite so bulletproof.

All of which goes to remind us just how quickly sentiment can shift and how volatile markets can be in the short-term. Year to date the Australian sharemarket is down around 11% -most of which has occurred in the past month or so.

Some people are calling it a buying opportunity - others see it as a reason to run for the exit signs.

Sentiment of the extreme kind - be it fear or blind optimism - is an investor''s natural enemy. The ally - by contrast - is found in high quality fixed interest assets and the prudence to diversify your risk across the major asset classes. When you look back at the global financial crisis high quality fixed interest investments was the standout asset class in terms of doing the job of protecting portfolios for investors.

Regrettably things like the VIX are measures of what is happening - not predictors of the future - and periods like these heighten the danger that investors respond in an emotive way after the event. Selling after a market has had a steep sell off and buying when markets have been rising is neither rational nor the way to build wealth over the long term. But there is plenty of research and market information to suggest that is all too common investor behavior.

The good news is that volatility declines with the passing of time which is why having a long-term view of your investments - particularly those linked to sharemarket values - is so important.

Times like these are pointed reminders to check on your portfolio risk level and understand the role that fixed interest plays at insuring your portfolio against periods of short-term volatility.