Dubai World and Evidence-Based Investing

Last week, the world stock markets experienced a “sell off” due to issues regarding debt payments (or lack thereof) from the country of Dubai.  I thought that I would provide for you a brief synopsis of what information is known and how it may affect your portfolio.  We do not believe this to be an issue of major concern.  In fact, investors with an outlook of more than a year - which should be everyone - will probably see very little effect on the long-term return of their portfolio regarding this issue, if any.  However, because the markets (and many investors, as well) seem to be waiting for a large correction, it seemed prudent to make a comment.

On Wednesday, November 25^th, Dubai World, a conglomerate that is owned by, and based in, the city-state of Dubai, announced that they were having difficulties making the payments on their debts.  Dubai World has asked the creditors of its roughly $59 billion in liabilities for a six-month moratorium on its debt payments.  The announcement immediately caused stock markets around the world to drop in value.  The decline continued on Friday.

How does this affect you?

As all clients with Aubry & Eustice know, we have a rather large exposure to international markets and we always have.  Using Evidence-Based Investing as our guide, the Standard portfolios have 50% exposed to markets outside of the United States and the International portfolios have 75% exposed to markets outside of the United States.  At this point, none of the Aubry & Eustice portfolios are exposed to companies that are based in Dubai.  In fact, the only Middle Eastern exposure our portfolios have are to companies that are based in Turkey.

The following is a list of the Developed Markets that we invest in outside of the United States:  Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.

We also have a relatively large exposure to Emerging Market countries as well:  Brazil, Chile, China, the Czech Republic, Hungary, India, Indonesia, Israel, Malaysia, Mexico, the Philippines, Poland, Russia, South Africa, South Korea, Taiwan, Thailand, and Turkey.

While we do not invest any money directly in Dubai, there are potential ancillary effects on our portfolios.  It is likely that we own stock in some of the banks that have loaned money to Dubai World.  These loans were taken in order to finance the massive real estate growth that has taken place there over the last five years.  But the number of companies is very small and the total exposure, relative the global markets, is rather small as well.  Yet, unlike the problems that were encountered in 2008, the liabilities of Dubai World seem to be relatively contained to Dubai. 

At this point in time, no one seems to know exactly what and who has been affected and for how much.  What is clear, though, is that many investors acted on emotion over the course of the last several days.  There is bound to be some after effects from the shock of 2008.  That is what this appears to be happening at this time.  More uncertainty has entered the market, and it is interpreted through the fears and reactions to the events of the last year.  To make matters worse, financial media are obsessed with the presentation of multiple talking heads in order to generate as many varied viewpoints as possible.  These attempts at “surrounding the issue with opinions” is designed to increase viewership, but it actually contrubutes to more uncertainty rather than providing the clarity they hoped for.

There is a possibility that this issue could turn into something bigger.  Meaning: there could be more countries and companies around the world that are going to have trouble paying their debts.  If that is the case, investors around the world may be concerned that putting more money into emerging markets is more risk than they are willing to take on.

There is a basic economic principle that says this: capital flows to where the expected return is the greatest.  While many people around the world collectively hold their breath, hoping for economic recovery, the evidence shows that the emerging economies are most likely going to provide the greatest returns over the long-term.

We talk and write about how risk and return are related.  That is, if there is a greater expected return with a particular investment, there is going to be a greater expected risk.  While counter-intuitive, one of the most unexpected and consistent findings of Evidence-Based Investing is that when riskier asset classes are strategically added to a portfolio, the risk (volatility) is minimized.  This is only seen in long-term investment philosophies, and it is precisely why Aubry & Eustice employs Evidence-Based Investing.

The three determinants of success continue to be the baseline for the guidance we provide for our clients:

1. Have a plan, specific to your goals

2. Maintain proper asset allocation, as determined by your tolerance for risk, relative to your goals

3. Manage your behavior by not making emotional decisions when it comes to your money and investments.

To your success!

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