The Caution Seldom Err or Write Great Poetry

Conventional behaviour might yield average good or bad results but only the non-conventional can produce above average or below average results. What kind of investors do you want to be? Average? Or great? To succeed in any pursuit of risk, we must learn how to accept losses. More judiciously, it is to ensure more successes than failures, and to make more gains on successes than losses on failures. Just like in basketball – for every shot not taken, it’s a 100% missed.

Over-diversification of portfolio will only bring about average results at best, because you are doing what other normal people are doing. Low cost, passive investments that emulate benchmark performs are for the average. The bold and great will take risk to concentrate on certain stocks, sectors or themes based on careful risk-mitigated actions (e.g. margin of safety).

An Iterative Framework to Portfolio Management

Managing your own portfolio might seem a daunting task at first hand if you are not in the investment business, but as in all academia cliche, having an iterative framework would help in understanding the key processes. So here’s one for the road.

Portfolio Management Iterative Framework

Step 1. Understanding Risk Preference

As with most decision in life, it all starts with understanding yourself. Likewise in investment and portfolio management, it is important to examine your own risk preference, in which it differs based on individual’s personality and stages in life. Typically, younger investors have higher risk tolerance than older investors, but the reason is commonly misunderstood. An older investor with limited earning years cannot withstand a poorly timed market downturn which could impact significantly on their retirement savings. Younger investor (in early 20s, 30s), however, have many years of earning power ahead and could cost average their investments given their longer time horizon. By asking yourself a few critical questions, where some of the investment sites offer for free (click the “Let’s Get Started” button), you can have a rough gauge on your risk tolerance.

Step 2. Identifying Asset Class and Investment Vehicles

There are typically a few types of broad asset classes ranging from stocks (equities), bonds to instruments like REITs and ETFs (Click here to find out more). Each asset offers different level of returns, volatility, and correlation among the classes. For example, stocks are a commonly held asset class but have substantial volatility due to periods of declines and gains over shorter periods. Investment-grade bonds, on the other hand, tend to provide much lower reward to investors, but these returns are much less volatile. In layman terms, they’re less risky.

The framework underlying proper financial management began in the 1950s and developed into broader tools for portfolio management called Modern Portfolio Theory (MPT). Stripped to its core, it’s about mixing of assets in a portfolio in response to the market changes, thereby affecting an investor wealth and adjustment of risk.

Two economists, Harry Markowitz (1952) and William Sharpe (1964), published a pair of groundbreaking papers that develop the mathematics to explain why assets like stocks and bonds do not all gain or lose value at the same time. As they are not perfectly correlated, hence when combined into a single portfolio (a mix of assets), this ‘imperfect’ correlation would reduce the variability in their combined return.

The implications? Find the best set of combination based on expected performances and variability (also known as mean-variance optimization) that caters to individual’s risk preference. Graphically, it is known as the efficient frontier.

Each point represents an optimal combination of the different asset classes at each level of risk, i.e. the maximum amount of return for that amount of risk. 

Step 3 & 4. Creating and Monitoring Portfolio by Matching Risk Tolerance

From both step 1 and 2, one can find the approximate match of assets to match your risk tolerance based on age, earning power, investment horizon and expected returns, By using Excel or Google sheets like the one shown in the BYOPM Resilient Portfolio, one can easily monitor and track returns, dividends on a real-time basis. If you are not sure, engage your Remiser or Trading Representative and demand them to help you! Monitoring performance is crucial as over time, decisions need to be made to rebalance the portfolio, which is the last step of the iterative framework.

Step 5. Rebalancing of Portfolio

Balancing your preference for risk and reward at different stages in life is important. Even with a constant risk profile, the market does change. For instance, a bull market may increase the prices of stocks and bonds low. Case in example, if you’d invested $10000 in stocks and $5000 in bonds (allocation of 2/3 and 1/3 respectively) and the stock market rose 20% while the bond market fell 20%, your portfolio would now be $12000 in stocks and $4000 in bonds. This means your portfolio is now 75% stock and 25% bonds. This is a definitely a much riskier portfolio. Rebalancing basically means adjusting the deviations such that when prices are high, one sells and vice-versa while locking in profits. Here’s a simple Excel sheet when one can do a rebalancing (Beginner Rebalancing Tool). For more advanced steps, seek advice from your Remisier.

Lastly, repeat step 1 to 5 as you go through different stages in life and prior to making important lifetime financial decisions (e.g. settling down, buying car or a house, retirement). That’s why this is an iterative framework. Thanks for reading and challenge yourself to build your own portfolio!

Further Reading

Markowitz, Harry, 1952. Portfolio Selection. Journal of Finance, vol. 7, no. 1, 77 – 91.

5 Key Questions Investors Should Ask About ETFs

1. What is an ETF?

ETF stands for Exchange-Traded Funds which is basically a basket of securities (stocks or bonds), listed and traded on the exchange. They provide access to local and international markets like China and India in a single trade. For example, you instantly own shares in 30 of the largest blue chip companies when you invest in the ETF that tracks the Straits Times Index (STI). ETFs are designed to trade at a price that tracks the market value of their underlying assets by updating their portfolio holdings on a daily basis. To align the trading price of the ETF shares  with the market value of their underlying assets, certain large broker-dealers, known as “authorized participants,” create and redeem shares directly with the ETF in large blocks, typically 50,000 to 100,000 shares.

2. What kinds of ETFs are available?

The vast majority of ETFs are index-based, i.e., they are designed to track the performance of a designated index like STI or S&P 500.  ETFs can categorised based on geography, capitalization rangnes, industry sectors, and credit quality.Some ETFs seek exposure to commodities. There are certain index-based ETFs which are “geared” multiple or inverse multiple of an index. Due to the complexity of such ETFs which are derivatives-based, they are classified as Specified Investment Products (SIPs) which required retail investors to pass certain qualifications

The silver lining to this requirement is that currently of the 87 ETFs listed on SGX, 8 are accessible to investors without enhanced safeguards and hence are classified as Excluded Investment Products (EIPs). However, SGX expects this to increase to up to 20 ETFs over the next few weeks. Refer to the following announcements by SGX dated 29 Apr 15.

http://www.sgx.com/wps/wcm/connect/sgx_en/home/higlights/news_releases/Diversification_made_simple_through_SGX_ETFs

Source: http://www.sgx.com/wps/portal/sgxweb/home/products/securities/etfs

3. Why should I invest in an ETF?

Efficient and Cost Effective in Diversification

Investor can achieve broad diversification can be achieved through a single transaction. For instance, nvesting in the STI ETF gives you similar returns at a lower cost, compared to buying 30 individual stocks (see table). Additionally, as ETFs are passive funds, the annual management fees are generally lower at less than 1% compared to unit trusts or traditional funds that charge at about 2-3%.

Transparency

Investors can readily access real-time information such as ETF prices, fund information and index information on the websites of the Issuers, Index Provider and SGX.  Market prices are published real-time throughoutthe trading day.

Control and Flexibility

Investors can buy and sell ETFs anytime during trading hours and may employ the traditional trading techniques including stop order, limit order and short sales just like trading any stocks.

Accessibility to Foreign and Commodity Markets

The wide range of ETFs offered on SGX allows investors to access multiple markets via a single platform. This provides an alternative for investors who may face difficulty in buying securities listed on stock exchange outside of their home country or markets that are not easily accessible.

Liquidity Provided by Market Makers

Most ETFs listed on SGX have market makers to provide competitive bid/ask prices. Investors can buy and sell ETFs anytime during market hours.

No Stamp Duty

There is no stamp duty for trading ETFs on SGX.

4. What are the Pros and Cons of ETFs?

5. What kinds of investment strategies can I employ via ETFs?

ETFs are simple tools which can be used for a wide range of investment strategies.

Strategic Allocation – Buy and Hold

ETFs cover many asset classes and markets and are ideal to be used as portfolio construction tools for long term strategic allocation, especially with their low management fees. Investors who bought ETFs can keep their ETFs indefinitely as long as the ETF is listed.

Tactical Trading

The transparency of ETFs information and intra-day liquidity allows investors to make opportunistic investment by ‘buying low and selling high” in anticipation of a changing market.

Core-Satellite Investment

In a core-satellite strategy, the core investment are often made of board based index products while satellite investment are normally represented by more concentrated investments that riskier and are expected to provide higher returns. Investors can build a core market portfolio with ETFs and add stock picks (satellite) for additional out-performance.  In this way, passive funds can be part of an active strategy.

Cash Equitisation

Typically adopted by institutions, ETFs can be used to convert cash into equities temporarily to minimize cash drag.

Hedging

ETFs can be used to hedge against other investment position. For instance, an investor may long a specific market segment while at the same time shorting an ETF.

References.

http://www.spdrs.com.sg/education/index.html

http://www.sgx.com/wps/portal/sgxweb/home/products/securities/etfs

SGX Education Video – Market Analysis Series

Here are the series of informative videos by SGX on the basics of market timings, trend forming (20, 50 and 200 Simple Moving Average [SMA]) and support and resistance zones. These are good introductory videos to the basics of investing and trading for beginner investors. Have fun watching!

SGX Education Video – Financial Ratio Shortcuts

Singapore Exchange has embarked on a series of educational initiatives to level the financial knowledge of retail investors in stock investing. Check out this video on the 7 essential financial ratios and what to look out for.

Investing Adages

Being too far ahead of your time is indistinguishable from being wrong. – Howard Marks

Quotes Worth Remembering

Predicting Rain Doesn’t Count. Building Arks Does.

– Warren Buffett

Quotes Worth Remembering

“The purpose of margin of safety is to render the forecast unnecessary.” – Benjamin Graham