An open letter to our clients


The only certainty is that nothing is certain.” —Pliny the Elder

 “It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.” —Mark Twain

These two quotes above were written 1,900 years apart yet they highlight two important lessons for investors from the recent events in Japan. One is the need to construct portfolios that expect the unexpected and anticipate the unanticipated. The other relates to avoiding one of the costliest traps that ensnares investors.

Before getting into detail on those lessons, here's a quick recap on the first quarter.

Market performance in the first quarter

Markets in January and February 2011 saw a continuation of last year's positive sentiment. This was spurred by solid corporate profits and a broad consensus that while the global economy might not experience a strong recovery going forward, it would see growth.

March did see a setback. The earthquake and tsunami in Japan on March 11, which took a dreadful toll on human life, have also clearly reduced short-term prospects for the global economy. The turmoil in North Africa, while positive for oil prices, also had a negative impact on markets due to concerns about the effect on consumer demand.

Notwithstanding this, developed markets generally saw gains at the end of the first quarter that put them on track for solid performance in 2011. Of note, results outside of the U.S. were boosted by the weak dollar. For example, first-quarter gains in Europe were 6% in dollar terms, 2% in local currency.

Source: MSCI index

Learning to live with uncertainty

If they operate efficiently, stock and bond markets incorporate all the available information at a given point in time.

What can't be anticipated are developments that are, by their nature, unpredictable.

We've had at least four such events in the past year:

·        Last April's volcanic eruption in Iceland that spewed ash in the air, shut down 100,000 transatlantic flights, and cost the airline industry $2 billion

·        Also last April, the explosion of the Deepwater Horizon oil rig in the Gulf of Mexico

·        Commencing in December, street protests resulting in changes of leadership in a   number of countries in North Africa, leading directly to the current military action in Libya

·        And, of course, the earthquake, tsunami, and nuclear-reactor crises in Japan.

In light of episodes like these, investors need to take away two key lessons.

Lesson One: Expect the unexpected

The only way to deal with uncertainty and manage the impact of unforeseen events is to build strict risk controls into portfolios, similar to those used by the most sophisticated pension funds. While the risk of one-time incidents can't be eliminated, through diversification and risk management, we can limit the damage when negative events occur—whether they be massive frauds such as Enron, sudden bankruptcies like the Lehman Brothers, volcanic eruptions, oil rig explosions, or earthquakes.

Rigorous review and rebalancing of your portfolio ensures that your investments remain diversified and we control the risk that accompanies overexposure to any one stock, industry sector, or geographic region. This is the only way to get some protection from things that simply can't be anticipated.

Lesson Two: Avoid overconfidence

Aside from the time entailed, there is one big negative to the risk-controlled approach to portfolio construction: in the short term and mid term, there will always be someone who's made a big bet that has paid off and who is doing better than you as a result.

The quote from Mark Twain at the start of this letter says it all. The sources of trouble aren't the things we've identified as question marks and causes for concern. Rather, what causes portfolios to crater are the things that we're absolutely positive about right until unanticipated occurrences catch us by surprise.  We've always had unexpected events and always will. And despite these unforeseen events, economies have grown, companies have prospered, and stock markets have generated positive returns.

I believe that we will work through the recent events and those investors with a balanced approach and a long-term view will be well rewarded.

Should you have any questions in the meantime, please give us a call.