An Economic and Policy Watch Update prepared by a major investment firm was brought to my attention recently. Titled It Just Can’t Get Worse, the report chided policymakers for actions that “look like a poor cover for loose money, rising inflation and fiscal problems.” The report warned that “government financing needs are corrupting monetary policy.”
In light of the recent news coverage surrounding national events and political and fiscal uncertainty, such a conclusion might seem unremarkable. But the focus of the report was not the United States but the government of Indonesia. This report was published on July 16, 2001.
Indonesia’s sovereign debt rating at that time placed it firmly in the “junk” category. At no time during this past decade did Indonesia merit an investment grade rating.
What would have been the experience of equity investors in Indonesia since this report was published? For the 10-year period following the report, ending June 30, 2011, the total return was 33% annually in US dollar terms. This far exceeds the return in US equities in spite of the fact that at no point during this period did Indonesia have an investment grade rating for its sovereign debt.
We are not suggesting that investors dismiss the effects of U.S. government actions. Nor are we suggesting that investors focus on countries with low credit ratings. Investors in Indonesia have had their share of ups and downs over the years.
Well then, what am I suggesting? Just as a broadly diversified portfolio includes companies with high and low credit quality, investing in countries with both high and low ratings is also sensible.
A low credit rating in and of itself is not necessarily a death sentence for equity investors. Citizens of both AAA countries as well as B countries eat, drink, get stuck in traffic jams and chat on mobile phones. Companies doing business in all countries generate cash flows.
The prudent investor will have exposure to both by diversifying in a global portfolio. Diversification spreads risk and can lessen the bumps in the road.
Nothing lasts forever. Smart investors temper their enthusiasm during good times and keep some optimism in challenging times. Moderation and diversification are good components of a prudent portfolio.
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