What could go wrong? It's a long list

Fear, not greed, drives ultra-conservative money managers like Danielle Park

BY PAUL BRENT


Globe Investor Magazine Online, Jan. 27, 2009

James Breech spends most of his time worrying about what could go wrong. It's a long list: stagnation, inflation, global recession and, for hard core pessimists, a category of really, really bad things his boutique investment firm groups under the heading of "chaos." They include a "tsunami" of corporate defaults, hedge funds going bust and unleashing a fire sale of assets, an emerging markets meltdown and the chance of an avian flu pandemic in the next few years.

"We are downside risk managers - our job is not to look at the bright side of things, our job is to try and figure out what could go wrong," said Mr. Breech, president and chief executive of Cougar Global Investments, at a recent investor presentation.

These days the Harvard-educated PhD in Hellenistic and Greco-Roman history is far more Dr. Doom than Dr. Feelgood. He is an avid follower of uber-bear U.S. economist Nouriel Roubini.

Mr. Breech's Bay Street firm, which invests the savings of entrepreneurs and older, typically more conservative investors with $100,000 or more to invest, describes itself as an asset allocator, not a market timer. Buy-and-hold strategies are for losers or for the lucky ones that get into the market at the start of bull cycles, he says.

The firm all but got out of equities in mid-January 2008 when its models showed the market headed for a deep slide, just like it piled into equities in March of 2003. Cougar Global has rung up 11-per- cent compounded returns for clients over the past five years with its active allocation model. The one-year return stands at 0.29 per cent.

"We had a great run until 2007," he said. "We were very early in, we have been 97-per-cent equities in the history of the company. This is the most defensive we have ever been."

Today, it has adopted an ultra-conservative, ultra-safe strategy, with a 68-per-cent bond, 32-per-cent money market mix that stipulates only government-backed securities. That is because Cougar expects things to get worse before they get better.

Most market observers have caught up with the firm's year-long prediction of recession for the United States in 2009. But Cougar handicaps a higher probability of economic chaos (25 per cent) than virtually all others, noting that the U.S. Fed is in a liquidity trap and the economy and banking system will not stabilize until a solution is found for the still-worsening U.S. housing crisis.

That means Cougar and its clients will be sitting on the sidelines as the economic crisis becomes a political one: "With the central banks out of ammunition it is going to be left in the hands of politicians," Mr. Breech said in a December call with investors. "It is going to have to be fiscal policy, it is going to political action to stabilize everything and that is why the next four to six months are going to be so frightening."

Unprecedented demand destruction

Fear, not greed, also guides the investment philosophy of Barrie, Ont. investment firm Venable Park, which also takes a very conservative approach with the money of its clients. Venable Park serves those with $1-million or more to invest and attracts those who have earned it, rather than inherited it.

"We've been out [of stocks] completely since May," said Danielle Park, president and portfolio manager of Venable Park. "We left financials in 2006.and we stayed with energy and gold until about May."

It also made a smart play on the U.S. currency through the purchase of U.S. treasuries in October 2007 and sold them in November 2008 for a tidy 22-per-cent return. That is the chief reason its clients are up about 6 per cent for the year. And while Venable Park keeps its clients happy in down markets like today, it lost some clients in the prior two years when it took a defensive position and began getting out of equities.

A believer in market cycles, Venable Park is closely watching to see whether the Canadian market falls as far back as the U.S. has from its peak.

"If the U.S. has retested the '02 low, Canada could do the same" said Ms. Park. "Our suspicion is we are not through the full correction yet."

Venable Park is hungrily eyeing equities priced "50 per cent off" but is still concerned that there are more shocks coming.

"We are in a new country of demand destruction that we haven't seen for decades," she said. "This is the worst global recession since the Second World War so none of us have any personal experience with how long, how deep this will go."

When the Barrie firm decides the time is right to jump back into the equity market, it will likely start with index-mirroring exchange-traded funds (ETFs), Ms. Park said.

"Really it comes down to our objective rules. Watching the money flow, counting the volume, selling pressure versus buying pressure. All of the stuff we follow tells us that we may see a bear market rally and then another selling phase yet, maybe once the Q4 earnings disappoint in early February."

Nothing beats cash

A market-wary approach has also served portfolio management company Castlemoore Inc. in 2008. The Oakville, Ont. firm selectively bought back into the TSX after January declines before liquidating most of its positions this past spring.

"That really paid off for us in Canada, but in the United States it just really rolled over, and that was kind of the clue" of unprecedented economic times," noted Ken Norquay, Castlemoore's chief market technician.

Castlemoore has since purchased one stock in July - Shaw Communications, which is "hanging in," and more recently, a small position in SPDR gold trust GLD. The rest of its clients' funds are currently in cash.

"If you are going to buy at the bottom, then you really have to have that cash," said Mr. Norquay. "We really don't want to buy too soon."

For Castlemoore's most recent one-year period ended November 2008, its return was 4.4 per cent for RRSPs and 14.6 per cent for cash accounts. (The 10-per-cent difference in return occurred because the cash accounts held significant amounts of U.S. dollars.)

Castlemoore is closely following the government-led bailouts of banks and trying to determine whether the efforts will instill confidence in the international finance system.

"Normally in a recession, you want to buy at some time," Mr. Norquay said. "Recessions come and go but the last time we had a banking crisis was in the early 1980s, so that just adds a little extra hot sauce."

Special to the Globe and Mail