The invisible hand of economics has just given the world a slap, Wingate Asset Management chief investment officer Chad Padowitz says.
Padowitz's assessment of the current mess in the global markets, however, may be a little understated.

The events of the past few months have not only turned the world's financial markets on their head but have defied the traditional thinking of free market economics. Globally, government bailouts are now in excess of $1.5 trillion. The invisible hand has not just slapped the world but also given financial institutions around the world a savage blow. 

For Nicholas-Applegate chief investment officer Horacio Valeiras the mood is decidedly bleak.

"In my 22 years in the industry, this is the worst mood that the country has ever experienced. Economic activity over the last four weeks has slowed down. People are fearful about their ability to pay their children's school fees and cutting back on their spending altogether. It's a feeling that has gripped the whole nation," Valeiras says.

So how are CIOs around the world keeping their mettle during these tumultuous times?

While the world has turned upside down, CIOs are still finding value in companies and, if anything, some companies are benefiting from the change forced upon them.

RCM's London-based chief investment officer, Lucy MacDonald, says there is now a flight to quality.

"Companies will be able to change from this crisis. We will continue to focus on the financial strength of corporations. We expect consolidation in the industry to continue, particularly in banking. There will be a flight to quality and the stronger will just get stronger," MacDonald says.

Despite the fact the United States is in recession and its banks have relied on government support, Valeiras is optimistic about the country's economy and believes quality companies can still be found. In fact, last year the firm shifted the Nicholas-Applegate Global Equity 130/30 Fund to overweight in US stocks (60/40).

"There is a difference between economic growth and investment opportunities. There are some stocks in the US market that will still provide us with opportunities. These stocks are predominantly from the healthcare and consumer industry," he says.

He believes some financial institutions will transform under the intense market conditions. As part of the firm's move to overweight in US stocks, Nicholas-Applegate also shifted its portfolio to overweight in US financial stocks.

"The larger banks like Northern Trust and JP Morgan will still be able to adapt to the changing market. The government program put in place is a combination of capital injection and the ability to sell assets to the Government. This will provide a floor for the banks," Valeiras says.

While economic powerhouses such as India, China and Brazil are able to sustain their growth compared with the developed economies, he says such economies offer a range of risks, including currency, economic and commodity. 

"Over the next six months, the US is the best place to be in terms of relative performance and that's what we are sticking to at the moment," he says.

Singapore-based investment manager Andrew Gillan says these risks are justified, particularly political risk.

"The political risks in this region are always going to be higher. There is always the potential for ruling parties and prime ministers to change," Gillan says.

However, unlike its counterparts in the developed markets, companies (and banks) in the Asia-Pacific region are better placed to weather the storm, he says.

Businesses in the region learnt from the mistakes of the 1997 Asian Financial Crisis, which transformed them into quality companies, he says, in particular their move to abolish higher gearing levels, practices that led to the credit crisis in western economies.

"There are positive drivers in the region that the rest of the world does not have. These include a growing and young population and rising income levels," he says.

He acknowledges, however, that Asia is not immune to a global slowdown.

"We therefore have a preference for domestic-focused companies over exporters. We also focus on consumer and financial stocks. Asia's strength now is its growth in domestic consumption, which these companies are well placed to benefit from," he says.

Despite the challenges facing the Asia-Pacific region, he says growth is still on track and he predicts 6 per cent growth compared to 1 per cent for the developed world.

"From an economic standpoint, the emerging markets in the Asian region are in much better shape than in the West. China has huge foreign exchange and current account reserves. The sovereign wealth funds have emerged in Asia, particularly from China and Singapore. Such funds have been able to take equity stakes in companies in the developed markets," he says.

The slowdown in the US and what has happened to US blue chip companies have surprised many people in the region, he says. In Asia, people are questioning the global regulators and how companies were allowed to become highly geared, he says.

Lessons learnt
Risks that were not prevalent a few years ago have emerged as significant, according to Padowitz.

"Liquidity and insolvency are now the single biggest changes confronting investors. We have had previous market darlings like Babcock and Brown struggling for access to capital," he says.
He notes the current crisis defies any historic market event and as such it is difficult for people to learn from history's mistakes.

"I don't think anyone alive today could compare a similar crisis that occurred during their working life," he says.

Without history to rely on, investors are facing some tough lessons.

Financial engineering will definitely be reassessed and may be part of history, according to Integrity Asset Management chief executive Paul Fiani.

"We have been talking about financial re-engineering for many years and whilst it is sad to watch it unravel, at least we were expecting it and positioned for it," Fiani says.

"Companies engaged in these practices are beginning to unravel. Those firms were built to operate in a world of cheap and loose credit.

That world is now gone forever. In a world where debt will cost more, those companies built on cheap debt will struggle."

An altered landscape
The market crisis may not just have implications for the way companies operate, but may also transform the investment landscape. As investors go back to basics and look for quality, some traditional forms of investing may be history.

With the listed property trust (LPT) sector under siege from the markets following its high gearing levels, Fiani believes dedicated funds in the sector may also be a thing of the past.

"The LPT sector is a mess. I think the future of LPT funds is highly questionable. The index is nearly 50 per cent Westfield. The idea of giving a fund manager money and then half of the money invested into one stock is silly. The client might as well buy that stock and save the fees," he says.

"Over the next 12 months people will see how problematic the LPT sector is. I think we will see investors look to their Australian equity managers to invest in the LPT sector rather than using dedicated LPT fund managers."

MacDonald notes index management may also come under scrutiny.

"By investing in the [international] index investors would have had exposure to stocks such as Freddie Mac and Fannie Mae. Active managed helps you to avoid these disasters," she says.

As an active manager, she says the process gives you the ability to distinguish the risks.

"Now is the opportunity for stock picking. Active management gives you the ability to understand the fundamentals of a company. By using in-depth insight, active management allows you to choose companies that offer quality and financial strength in the balance sheet. You are not going to have that by simply investing in the index," she says.

Fiani backs up her view.
"During the bull market, the worse the company, the more it went up and index funds benefited from having exposure to poor companies.

Over the coming years the key to successful investing will be to invest in quality companies that have proven business models and a conservative approach to debt and to avoid the ones that don't. Index management gives you exposure to all companies regardless of fundamentals and thus guarantees exposure to all corporate failures" he says.

MacDonald also believes there will be a major reassessment of the way regulators have managed risk.

The right regulation
"There has been a huge failure on the regulators' part to predict what happened. The Basel regulation in particular will come under scrutiny following the collapse of banks around the world," she says.

The Basel regulation introduced capital standards for banks around the world. The problem, she says, was that such a model was uniform and in a sense banks were captive to the same systemic risk.

"The regulators have effectively increased the systemic risk by using modelling that did not predict the failure. Hopefully in the future there will be more intelligent use of quality modelling," she says.

She believes there will be a "philosophical approach to the reassessment of risk" in the future.

"What has happened with financial markets has questioned the role of capital in open markets. Who is best placed to oversee both the regulation of these markets and protect people we still do not know," she says.

For Padowitz the move to over-regulation will be worse than free enterprise.

Recalling his history lessons, he says that after the Great Depression in the 1930s, regulation went significantly overboard.

While he supports the US Government's bailout plan, he believes in the long-term over-regulation will hamper the ability of global capital markets to allow quality companies to operate.

"That is why that after the Depression we had 20 years of slow growth. Over-regulation in the short term may be better. But in the long-run, companies with a profit motive are still better placed to perform better than any government. There is a risk that regulation will go too far and the world will be a poorer place because of it," he says.