In Times of Crisis
by Barb Clapham

That there is a link between the presence of danger and the potential for opportunity has been known since ancient times by the Chinese. The word 'crisis' in Chinese is shown as [?], the character on the left signifying danger and the character on the right standing for opportunity. The focus of a crisis often splits evenly between these two ideas.

This association gained widespread acceptance from the business community around 1776, when Adam Smith argued in the Wealth of Nations that individuals will invest resources so as to earn the highest possible return. It follows, Smith wrote, that the risk-adjusted return on different investments must be equal.

Much has changed since Smith's time. Knowledge about risk has increased exponentially, as has the variety of risks. Investors now have to pay attention to systematic risk, inflation risk and mirror risk, to name a few. (If you are not familiar with the latter term, John Prestbo, editor of Dow Jones Indexes explains the concept in his article, which is part of our special report on risk.) With the increase in foreign content limits and investors generally investing more beyond our shores, currency and political risk must also be taken into account.

And what of our local markets? A general feeling of uncertainty seems to be plaguing the markets lately. The prices of stocks of many technology companies have dropped and signs of economic slowdown are appearing. Many economists are pointing to a possible slowdown or bear market ahead.

Risky markets, indeed. But remember the character on the right. Where there is risk, opportunity can also be found. Considering the current fixed income market, many governments around the world have reduced their deficits and worked towards getting their fiscal houses in order. As a result, government debt issuance is on the decline and institutional investors must look more to corporate bonds to satisfy their fixed income requirements. It is true that increasing the amount of corporate bonds over government bonds introduces more credit risk into the portfolio, but it also creates significant opportunities for higher return and improved portfolio performance. Careful analysis of individual companies will be a must.

In equity markets, analysts will need to have in-depth understanding of the products and services each company under review produces. As technological advances continue, certain products and services will be in greater demand, potentially resulting in higher prices for these stocks.

Improved risk tools have been developed to measure and manage risks. Losses can't be completely avoided, but they can certainly be mitigated. On the other hand, opportunities will likely be harder to find in the upcoming months. But the relationship that has continued since the beginning of time will not change: where there is risk, opportunity is right next door.

Contex Group