What Private Investors Can Learn From the Greek Disaster

For the last few weeks we have been witnessing a Greek tragedy as it became obvious that the government of Greece was having increasing difficulty refinancing its mounting debt. The spread on Greek Euro bonds (which is the difference on interest between a Greek and, say, a German government bond) has been soaring. The Greek state has more than euro 300 bn of debt outstanding. Even with the most draconian of budget cuts it will be hard, in the long run, to save Greece from insolvency.

Portugal, Spain, Italy, and Ireland are the next in line for potential debt problems – at least this is how the fixed income markets and ratings agencies see it, as the spread on the debt of these countries has also risen sharply and ratings have been slashed.

It is difficult to say how the whole story will play out because there are a number of political protagonists with different interests and different policy options. But two things are for sure: firstly, it is unthinkable that the EU or the IMF can bail out more than one or two countries because the overall amount of debt of the PIIGS countries is just too gigantic (not to speak of the other countries that might also get in trouble at some point). Secondly, following on from the first point, private investors need to rethink their long-term investment strategy with regard to risk and government debt .

During the financial panic in 2008/2009 many wealth managers and private banks advised their clients to stick to so-called safe investments. Many investors have taken this advice to heart– and government bonds have since shown an unprecedented rally. It is all the more ironic that it turns out now the supposedly safest havens are much riskier than expected. In addition, many investors who changed their portfolio allocation from being overweight in stocks to being overweight in fixed income have missed the rebound of the stock market into the bargain.

Therefore, private investors need to draw the right conclusions from the Greek debate as the common notion of risk has to be reconsidered. We have five take-aways that every investor should discuss with his or her wealth adviser when evaluating their future portfolio strategy.

1. Government bonds, even from the most developed countries, can no longer be considered a safe haven. It is obvious that the PIGS countries (Portugal, Italy, Ireland, Greece, Spain) have shown little fiscal discipline and face almost insurmountable public debts. But Germany, France, the Netherlands, and many other Western countries have gone down the same road. Given their demographic profiles, they will face the same problems in only a few years if they don’t  turn around current policies.
   

2. Don’t trust the rating agencies. Again it has taken S&P, Moody’s and the other rating agencies years to realize the implications of reckless fiscal policies. Only when the value of Greek government bonds was imploding did they downgraded their rating to junk status. months, even years too late.
   

3. You should trust your wealth adviser probably even less. As many banks advised their clients to go into fixed income and shun stocks back in early 2009, they were following the herd psychology just as much as most investors did. Some of the banks stayed defensive until early 2010 – a catastrophe for their clients, who lost a fortune in the crash and were prevented from recovering during the bull market in the 2^nd half 2009.
   

4. Ask all the pertinent questions. Make sure you understand how much sovereign debt you have in your portfolio. Ask your wealth adviser to also check all your fixed income and money market funds to identify the “fishy” assets. Keep an eye on your structured products, too,; the issuer of a product might have a lot of exposure to bad debt and the underlying assets may be problematic as well.
   

5. Re-evaluate your overall risk profile with regard to sovereign debt. Many studies have shown that the long-term historic return of government bonds has been below stocks, corporate bonds and real estate. This is consistent with the lower historic volatility of government bonds. However, you have to take into consideration long-term risks and so-called “black swan events” (huge risks with low probability that strike nevertheless at some point in history) of government bonds like hyper inflation, government defaults or even the failure of a currency union. Remember that the world has seen examples of total wipe out of government debts of developed countries, such as Germany’s monetary reform in 1923, which ended years of hyper inflation but left most creditors with a total loss of their assets. You may come to the conclusion that lowering your overall exposure to government bonds or shifting your exposure to countries with much lower debt levels is advisable.  

• How to Keep Your Private Banker from Disastrous Mood Swings
• Making the Right Asset Allocation
• Insufficient Client Focus – A Survey of European Private Banks