Embracing change, controlling risk

Zoomer | January 1st, 2006

Forces of change continue to blow through jittery, volatile, markets that are still searching for sustainable new support levels.

In the process, many high flying “dot-coms” have been reduced to irrecoverable dot-bombs and a host of day-traders, speculators and gullible newcomers taught a painful lesson that successful investment is never easy — particularly without proper discipline and planning.

Adding to the all-round discomfort is a veritable floodtide of explanatory and interpretive opinion that leaves little doubt that the experts have no idea where agitated markets are likely to settle in the short term.

Even Buffet can’t predict future

At least the legendary Warren Buffet was quite open about his forecasting inadequacies: “I’m no good on these macro predictions … The good thing about my economic predictions is that I pay no attention to them whatsoever.”

Instead, he stood by his belief that investment in great, well-managed businesses build wealth best over time. Though Berkshire Hathaway’s share price experienced a dismal 1999, Buffett saw nothing magic in a single year and confidently expects it to outperform the broadlyepresentative Standard and Poor’s 500 index over the next 10 years. Bravo: a consummate investor about to turn 70 is still thinking long-term!

What mere mortals like you and I should be doing when even the experts can’t get it right is a legitimate question. I suggest sticking with the longer-term investment strategies we have set for ourselves (here, I agree wholeheartedly with Buffet), while examining the one element of investing that it is within our power to control at this difficult transitory stage — namely, the degree of risk to which our portfolios are exposed.

In my view, such re-examination must embrace — rather than ignore — the vast forces of technological change that are impacting on all aspects of our lives, and that the economies and securities markets are currently grappling with.

While Buffett steadfastly refuses to invest in high-tech because of the impossibility of forecasting where they will be 10 years hence, 75-year old Ken Thomson reported at his corporation’s annual meeting how excited Thomson Corporation is by prospects in the age of the Internet, and how the company is enthusiastically investing in technological change in the communications industry for this reason.

I agree with Buffett on the need to understand what one is investing in, but feel even more strongly that Thomson is right in trying to understand today’s new technologies so as to participate in them — while controlling attendant risks.

Balance earnings and potential

For example, in the "must have" communications sector, risk could be reined in by focusing more on current and less on future earnings: for example, on a Nortel Networks, and/or a Thomson Corporation with their substantial existing earnings and cash flows rather than America Online where so much more is predicated on the future in price-earnings terms. Another way to shift position to where established earnings and better relative values lie would be to increase portfolio weightings in favour of established "Old Economy" stocks on the leading edge of technological change. Industry leaders such as Bombardier, Suncor Enterprises and Toronto-Dominion Bank are included in my Canadian six-pack for this very reason. Still further examples would include renamed Brascan and Canadian Tire. In all these examples, avant-garde leadership underpinned by core earnings and cash flow should be the key determining factor – not mere cheapness.

Still another way to embrace change while controlling risk would be to take a global industry rather than a geographical approach; for example, in the telecommunication sector, to weigh the relative attraction of Nortel Networks, Nokia and Ericsson, not because they represent diversification in Canada, Finland or Sweden, but because they are world leaders in their own right. Financial services are another example of global industry attraction, with Merrill Lynch – and Merrill Lynch Canada – coming readily to mind.

The degree to which portfolio weights should be shifted to better control risk will depend heavily upon individual investor circumstances. Each of us should try to challenge our financial advisers and ourselves in the process. By embracing change and controlling portfolio risk, we will not forgo the potential for longer-term global investment rewards. This way, we will also be able to capitalize on the opportunities to build even better investment value down the road. It’s a combined approach I like to think even long-term septuagenarians like Warren Buffett would agree is sound.