How the Woes of the Wealthy Can Guide You to Global Investing Profits

By Martin Hutchinson
Contributing Editor
Money Morning/The Money Map Report

The Capgemini/Merrill Lynch World Wealth Report appeared last week and it makes for some grim reading.

But it also provides global investors with some insights into the best markets to invest in.

The global population of high net worth individuals, or HNWIs - those with investible assets of more than $1 million - declined 14.9% in 2008, while their total wealth dropped 19.5% to $32.8 trillion. Throughout the world, there are now 8.6 million high-net-worth investors - millionaires or better, the report concludes.

Among the ultra-high-net-worth-investors (ultra-HNWI) - those with investible assets of $30 million or more - the population plunged 24.6% and their wealth by 23.9%. That's as you might have expected, in a year when global equity values fell close to 50% and real estate was also weak. Nevertheless, there were some regional variations that were significant - and that should help us decide which global markets to play for profit, and which ones to avoid.

Location, Location, Location ...

For a start, how bad the year was depended very much on where you lived. German HNWI wealth declined only 2.7% in U.S. dollar terms, and Brazilian HNWI wealth only 8.7%, in spite of a sharp fall in the value of the Brazilian real against the American dollar. At the other extreme, Hong Kong-based HNWIs saw their wealth decline 61.3% and Indian HNWIs 31.6%, in spite of the fact that the Indian economy remained robust.

These disparate performances reflect the different asset allocations of the various HNWI groups. German and Brazilian HNWIs invest primarily in bonds, while - at the opposite extreme - Hong Kong HNWIs were very heavily invested in stocks, with the total value of the Hong Kong stock market being five times the island's gross domestic product (GDP) - the highest ratio anywhere the world.

U.S. and British HNWIs found themselves among the worst performers on the list, reflecting not only the downturns in their stock portfolios but also their tendency to invest in hedge funds and "structured investments" sold to them by Wall Street that proved to be thoroughly unsound. Indeed, the worse relative performance of ultra-high-net-worth investors compared to their more-modestly wealthy peers was due to the tendency of the ultra-high-net-worth crowd to invest more aggressively, using leverage and investing in hedge funds.

(Ultra-HNWIs are of course more attractive "marks" for the slick salesmen of Wall Street because their wealth is greater and the commissions that can be generated correspondingly more juicy.)

The wealth performance of HNWIs has important implications for us as non-HNWI global investors. A market such as Hong Kong - where the wealthy last year lost 60% of their money - is likely to be highly unstable, with a high level of bankruptcies in entrepreneurial companies whose founders are in financial difficulty. Conversely, the relative stability of German and Brazilian wealth suggests there should be no real reasons that the current worldwide recession should lead to any real problems in the small businesses operated in Germany and Brazil. As investors, we should seek the stable - as opposed to the volatile - particularly in such difficult economic circumstances as those we face here in the U.S. market; hence, both German and Brazilian investments should be looked at closely.

In general, Latin American HNWIs did relatively well as a group in spite of the economic problems and attacks on the rich in such badly governed countries as Argentina and Venezuela. Hence, investments in politically and economically stable Latin American countries such as Colombia, Chile and Mexico may be attractive.

Inflation a Growing Concern

A second lesson investors can learn from the experiences of the HNWIs is that many of the so-called "alternative" asset classes provide poor diversification. Real estate and commodities did poorly in 2008, while hedge funds and structured investment vehicles did only slightly better than equities - but with a lack of transparency and an excessive fee structure that made those alternative investments truly unattractive.

Each investor will be more comfortable with some of these investment areas than others; if you are involved day to day in real estate, you may be more able to understand risk in that area than in tech stocks or exotic emerging markets, for example. Nevertheless overall investors are well repaid by devoting a higher proportion of their investible assets to cash and bonds, and a lower percentage to alternative assets that in reality provide little useful diversification in a downturn.

Apart from the performance of their investments, The Global Wealth Report also showed us that HNWI purchases of such luxury assets as private airplanes, yachts and luxury cars also declined, although sales of such lower-cost (on a relative basis) items held up fairly well (even in a downturn, millionaires feel the need to pamper themselves, even if it's just a bit).

Most notably, the Forbes "Cost of Living Extremely Well Index," a price index for high-end luxury items continues to at more than double the rate of inflation: From 1976 to 2008, it was up 800%, compared with 360% for consumer prices generally. That probably reflects the increasing disparity of global wealth, with planetary nouveaux riches pushing up the prices of all their favorite goodies. But if the recession drags on for several more years, expect the ripple effects to show up in such places as the art market, or in the demand for luxury autos.

Apart from putting all your money in cash and bonds (which will not help if we get high inflation, about the only one of the deadly financial plagues mercifully absent in 2008), The Global Wealth Report offered no real defenses against sharp wealth downturns in recessions. I would suggest one only: A purchase of long-dated out-of-the-money index "put" options, traded on the Chicago Board Options Exchange. In flat or rising markets, these will lose you money, but they have the huge advantage that in a real bear market - such as that of September to March - they will potentially provide a real lump of cash if sold near the market bottom. And that cash can then be used to buy stocks and other assets while they are at their cheapest.

The final strategy is much simpler and more direct: In a market collapse, you want your portfolio to be focused on Brazil or Germany, and not Hong Kong!

[Editor's Note: When it comes to global investing, longtime market guru Martin Hutchinson is one of the very best because he knows the markets firsthand. In February 2000, as part of the Financial Services Volunteer Corps, Hutchinson worked with Macedonian Minister of Finance Nikola Gruevski (now that country's prime minister), and crafted a plan that allowed Macedonia's 800,000 residents to recoup $1 billion in savings that had been siphoned away during the breakup of Yugoslavia.  As a featured writer in Money Morning, Hutchinson regularly writes global market "pick-and-pan" columns that show investors which countries to profit from, and which ones to avoid.

Hutchinson has now brought that same creative analysis to his The Permanent Wealth Investor trading service, which combines high-yielding dividend stocks, profit plays on gold and specially designated "Alpha-Dog" stocks to craft high-income/high-return portfolios for his subscribers. Hutchinson's strategy is tailor-made for periods of market uncertainty, during which investors all too often go completely to cash - only to miss some of the biggest market returns in history when market sentiment turns positive. Hutchinson's service is designed to generate high yields even during those sometimes-long-waiting periods. To find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor - please just click here.]

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