Morningstar Advisor - Fall 2008 - (Page 21)

Investment Briefs During Financial Crises, Stay Balanced Investors should avoid becoming too aggressive with their portfolios during financial crises and stay diversified, says Jim Licato, research and communications manager in Morningstar’s Advisor business. Licato researched market recoveries after five recent financial crises. He found that bonds did a good job not only mitigating a portfolio’s losses, but also helping generate gains. As the charts below show, a portfolio composed of 60% stocks and 40% bonds frequently outperformed a 100%-stock portfolio immediately after a crisis and over longer time frames. In fact, the diversified portfolio performed better than the all-equity portfolio in each three- and five-year period after a crisis except one: Five years after the October 1987 stock market crash, the stock portfolio’s cumulative return was 96.8% and the balanced portfolio’s return was 89.6%. Although loading up on stocks when the market is producing plenty of bargains is tempting, it might be best for investors to let the dust settle first. Morningstar Advisor is offering these charts to advisors for free. To download them, go to http://www.MorningstarAdvisor.com/products/ crisis.asp. Fannie and Freddie Effect: Mortgage Bargains Despite the gloom and doom in the financial markets, there are potential bargains to be had for bond-fund investors, Morningstar fixedincome specialist Eric Jacobson says. And one sector that appears to be a good deal is mortgage-backed securities. The government takeover of Fannie Mae FNM and Freddie Mac FRE, while extremely troubling in a broader context, effectively put the mortgage-backed securities guaranteed by the two agencies on the same footing as “full faith and credit” Ginnie Mae mortgages and U.S. Treasuries. In normal times, Jacobson says, risky bonds that gain the backing of Uncle Sam immediately start to trade at higher prices and lower yields, as though quality were no longer a question. But these aren’t normal times. “Mortgages did rally,” Jacobson says, “and some investors made a killing at the time of the takeovers. But if you look at government-agency mortgage yields relative to historical norms, mortgages are still an unpopular asset class right now.” Jacobson says that high-quality mortgages are on sale because investors who have troubled assets on their books and face liquidity issues have had little choice but to dump high-quality assets in order to stay solvent. “We saw it with municipal bonds, and now we’re seeing it with mortgages,” he says. “Unfortunately, it is a common symptom of this crisis.” U.S. Market Recovery After Financial Crises Portfolio: 40% bonds, 60% stocks 100% Return 80 60 40 20 0 –20 –40 October 1987: Stock market crash August 1989: U.S. savings and loan crisis –4.8 14.2 5.2 –0.2 –2.0 –2.3 4.0 34.2 34.6 13.2 12.3 11.3 20.3 10.2 –2.1 –0.7 3.0 5.0 –7.1 –15.3 19.6 59.2 89.9 After 1 month After 6 months After 1 year After 3 years After 5 years 42.3 –8.9 September 1998: March 2000: Long-term Capital The dot-com crash Management’s bailout September 2001: Terrorist attack Portfolio: 100% stocks 100% Return 80 60 40 20 0 –20 –40 October 1987: Stock market crash August 1989: U.S. savings and loan crisis –8.2 14.7 5.5 –0.4 –3.9 –5.0 34.1 30.1 8.1 58.0 96.8 After 1 month After 6 months After 1 year After 3 years After 5 years 27.3 27.8 6.2 5.1 –3.0 –3.6 –21.7 –40.9 –14.8 September 1998: March 2000: Long-term Capital The dot-com crash Management’s bailout Of course, mortgage-backed securities aren’t out of the woods yet. Although highly unlikely, Portfolio 40.1 a40% in prepayments caused by refinancing spike bonds 60% stocks homeowners would trigger losses. For that to 12.6 11.0 happen, Jacobson says, financial firms must 1.9 dramatically ramp up lending again. What’s harder to predict, he says, are market yields. If –20.5 yields rise significantly—because of inflation or concerns over the deficit—and prospects for September 2001: future refinancing dim, mortgages originally Terrorist attack priced with a high prepayment expectation can MorningstarAdvisor.com 21 http://www.MorningstarAdvisor.com/products/crisis.asp http://www.MorningstarAdvisor.com

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Morningstar Advisor - Fall 2008 Contents New on MorningstarAdvisor.com Letter from the Editor Contributors Inbox Are You Preparing for Higher Taxes? State of Financials Oracles of Alabama Investment Briefs Managers’ Investment Secrets Revealed Conformity Becomes a Growing Concern at American Gimme Shelter Location, Location, Location Rooted in Buffett, Going for Growth Keeping Little Company Away from the Numbers Consumer Confidence What about Natural Gas? TIPS to Beat Back Inflation Investing in Hidden Assets Funds That Have an Edge Come Tax Time Mutual Fund Analyst Picks 50 Most Popular Equity ETFs Undervalued Stocks Most Popular Variable Annuities New at Morningstar One for You, 19 for Me

Morningstar Advisor - Fall 2008

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