Higher interest rates, (the highest in a decade), higher food prices, higher health costs, petrol prices going up and up, share prices falling, property prices falling, falling consumer sentiment, a recession, etc. Do we have your attention?

At first glance, the latest news from Wall Street is not comforting. On Sunday 16 March 2008 JP Morgan Chase agreed to buy all of Bear Stearns shares for US$2 each, for a total of about US$270 million. A year ago, shares of Bear Stearns sold for US$170 each. In effect Bear Stearns was bankrupt. The sale avoided the cost of actual bankruptcy and ensured that the financial markets could continue to operate.

The key message here is not that a major investment bank has failed (and that others may fail, or investors think they may fail), rather it is the fundamental importance of liquidity to the proper functioning of the financial markets. This was the reason behind much of the activity of the US Federal Reserve (known as “the Fed”) of late. The Fed has been extremely active in doing pretty much anything it can do to maintain liquidity in financial markets.

But the purpose of this communication is not to rehash financial markets news: that is moving too rapidly to keep abreast of in a communication such as this. Rather, our purpose is to discuss this issue of liquidity and how it relates to your investments. We know the concept of liquidity from our own assets. We know that a house is an illiquid asset because it often takes a long time to find and buy or to market and sell. There are also a lot of costs involved, such as time costs, real estate agent fees, legal fees, removalist costs and taxes. If we wanted to sell a house in a hurry, such as today or tomorrow, we could do so but most likely we would have to take a significantly lesser amount than what we thought was fair. On the other hand, if someone was selling a house in a hurry we would probably offer a price much less than what we (or they) would consider a fair market price. This would make up for the fact that we had less time to conduct due diligence on the property. Even if we later find asbestos or termites in the building, the discount would help “pay” for the lack of pre-purchase information. Cash, on the other hand, is a highly liquid asset. We can pay for things immediately. If we want to buy an asset, there is little time involved. We go to the bank, get the cash, and pay for the asset. Another form of liquidity is having a line of credit at the bank. The bank has promised to give us cash when we ask for it. In return, we put up security on less liquid assets.

The situation that the failed investment banks, finance companies and property groups have got themselves into is that they thought they had liquidity because of the securities they owned or the relationships they had with their lenders. When their securities turned out to be less liquid and less diversified than they thought and their lenders turned their backs, they got into severe financial trouble. 

Your investment portfolio can be looked at in terms of its liquidity. You have highly liquid assets, such as cash, and less liquid assets, such as shares and/or property. The important thing is that your liquidity is less than your investment horizon. This means that you have plenty of time to sell your assets for a fair price before the money is needed to meet your future obligations. In addition, your investments are diversified both across asset classes and within asset classes.

This gives you a unique advantage: Patience.

While Bear Stearns and others have had to sell their assets at cents on the dollar after a weekend of huddled conferences, your investment time horizon and diversified portfolio means that you can stay invested for the medium to long term. If some of your investments have been oversold due to turmoil and panic, you have the ability to sit back patiently in the knowledge that over time common sense and sensible valuations will prevail. 

Also, buying when others have to sell usually means there are opportunities in the markets. The opportunities relate to the price and true value of assets. The price of something is how much a seller is asking for a particular asset and the value of something is how much an asset is worth relative to other similar assets. However these opportunities can sometimes take some time to eventuate and in the short term continued volatility is to be expected.

We will continue to monitor the financial markets and we remain committed to the belief that a well-diversified portfolio designed to match your time horizon and risk tolerances provides you with the best chance of meeting your investment objectives.