Introduction
Taking a break
from the Kingsmen series, I decided to pen down my thoughts on portfolio
construction and management, which is a topic which investment bloggers seldom
(if ever) write about. During my time in the investment industry, I have had
the privilege of speaking with (and some may say "interviewing") many
hedge funds in order to ascertain if they are worthy of investment into, and I have
met many CIOs, CEOs and also Investor Relations personnel while doing due
diligence on these Funds. Some of the questions would invariably revolve around
the construction of their portfolio, the characteristics of it, how they
measure performance and how they monitor positions for risk and valuations,
amongst others. In case the reader is wondering, portfolio construction and
position sizing is actually of great importance in determining overall returns,
and most investors would prefer to concentrate on what to buy/sell rather than
how to manage a portfolio on an aggregate, macro-view level.
From these
meetings, I have built up a good mental model of how one should go about
structuring and reviewing their own portfolios, and I shall try my best to
articulate these thoughts here. I may miss out one or two points as this is a
discussion which can take up quite a bit of space, but I think below are the
salient points which I could like to make and which an investor should take
into consideration in reviewing their own portfolio's asset allocation.
Portfolio Construction
Position Sizing
As one begins
to allocate capital, one has to be aware of how large a position one takes in a
particular security with respect to the portfolio. This would impact the
exposure of each position to losses and conversely, how well the portfolio
would perform should there be significant gains. Some investors prefer to set a
limit on their largest position so as to cap their exposure in case something
goes horribly wrong - for example a 5% maximum position for a $100,000
portfolio means you do not invest more than $5,000 in any one company. What I
would recommend is to look at risk-reward trade-offs in order to determine
sizing for each position - positions with less risk should ideally be scaled up
higher in % terms compared to positions with more risk. Of course, risk itself
is subjective and cannot be quantitatively measured (no, beta is NOT risk), and
the investor has to review each position to decide on the amount of risk versus
reward which he is expecting. Obviously, this is not an easy task but it is
important and the investor should therefore spend time to think this through
before proceeding. I have heard cases of high-conviction positions which have
suffered badly due to a negative event, and this unsurprisingly causes
significant drag on portfolio performance.
For myself,
Kingsmen Creatives is my largest position at around 25% of my portfolio (based
on market value, vested portion only, excluding cash), and this is probably the
maximum limit I would go for a single position.
Number of Positions
This is
determined based on the ability of the investor to properly keep track of the
business behind each security, and also the comfort level with which he has
over its business characteristics. Of course, every investor differs regarding
the amount of information and monitoring he can handle. What I would recommend
is around 8 to 10 positions for a concentrated portfolio for a full-time
working adult, and around 15 to 20 positions for a full-time investor (i.e. no
day job). This is just a suggestion and is by no means a definitive guide to
the "right" number of securities.
For myself, I
currently have 11 positions but am aiming for around 14-15 positions in time to
come, and as I do more deep research on other promising companies.
Sector/Industry Exposures
Another aspect
to look out for is the sector or industry exposure for each position, and to
assess if there are any overlaps or gaps. For example, if an investor is
investing into a portfolio consisting of (for example) only property developers
(CDL, Capitaland etc), then he is only exposed to real estate as an asset class
and industry and therefore his risks (and rewards) would be concentrated on
just one sector. This would obviously be a boon if the sector does well, but it
would mean that the entire portfolio is exposed to risks belonging to just one
sector and there is no way to buffer against negative events (e.g.
government-imposed cooling measures).
Ideally, an
investor should try to diversify his exposure to different industries. There
are two reasons for this. Firstly, he should try to capture growth from the many
different industries out there which show promise and positive trends, examples
of which could range from artificial intelligence, advances in cancer research,
self-driving cars, tourism boom etc. By just limiting himself to one sector, he
is missing out on potential growth in a myriad of other sectors. Secondly, he
should diversify to lower the risks of a blowout or negative event in any one
particular sector, an example being the Chinese Government's recent move to
limit the release of games subject to more stringent conditions being imposed.
This would have hit game developers across the board and caused their
valuations to plummet. If the investor had only limited exposure to this
sector, then his investments in other sectors would provide buffer for the entire
portfolio.
To use my own
portfolio as an example, I am exposed to the following industries with regards
to each position, and I feel this sufficiently diversifies my portfolio:-
Boustead Singapore and Projects
- Geo-Spatial Technology (Indonesia, Australia), Oil and Gas (global),
Industrial Real Estate (Singapore, Malaysia, Vietnam, China)
Straco - Tourism
(Singapore and China)
Kingsmen Creatives -
Thematics, Events, Exhibitions, Retail and Corporate Interiors, IP ownership (South-East
Asia)
Design Studio Group
- High-end furniture manufacturing, joinery work (Asia, Middle East, USA)
iFast Corp - FinTech
Platform provider (Singapore, Malaysia, Hong Kong, India and China)
FLT and Keppel DC REIT
- Australian and European industrial properties and data centres respectively
Suntec REIT - Retail
malls in Singapore, commercial property in Singapore and Australia
NetLink NBN Trust -
Fibre Network cabling in Singapore
VICOM - Testing and
inspection services (Regional + Asia)
Country/Region Exposure
Equally
important is also the portfolio's exposure to different countries and regions.
Some would argue for direct investment in the stock markets of other countries,
but I feel that there are two major risks here - taxes and currency, which may
negatively impact the portfolio. Therefore, one can gain indirect exposure to
other regions and countries through investments in Singapore-listed securities.
As can be seen
above, I have exposure to mostly South-East Asia and North Asia, with only a
few companies (e.g. Boustead SG and Design Studio Group) giving me global and
Middle Eastern exposure too. I feel that there is more than enough growth in
this part of the world which the portfolio can capture, without venturing too
far from Singapore. On the other hand, investors may wish to invest in
international companies such as Unilever, Nestle, Apple or Amazon (just to name
a few), but these have their own risks (taxes, forex) and also generally higher
valuations which one has to be mindful of.
Presence of Dividends (and Dividend Yield)
Another
important criteria which one should evaluate for their portfolio is whether a
security pays dividends. Dividends can form an important component of total
return for a portfolio (for info, for my portfolio, it is 2/3 dividends and 1/3
capital gains for all my realized gains). One should review the frequency of
dividend payments (e.g. iFast pays quarterly, and so do most REITs) and also
the historical dividend yield.
Dividends are
good for cash flow if one is a long-term investor and does not wish to actively
transact, therefore the liquidation of any position (even partially) may be a
very uncommon event. This means the investor would have to rely on dividends to
extract some form of cash flow from his portfolio. These dividends can also be
reinvested in order to enjoy the much talked-about compounding effect over
time.
Note that
every company in my portfolio pays a dividend, except for Design Studio which
is at the trough of their cycle (and hopefully it will start paying again when
things recover), so readers can tell that this is a very important criteria for
me.
Cash Level
This is a
question I always ask Fund Managers at the end of every meeting - how much cash
do they typically keep within a portfolio? The usual answer varies from 0%
(fully vested) to around 15%, but the average usually hovers around 5% or so.
So what exactly is a "cash level" and why is this so important?
The cash level
within a portfolio would indirectly show an investor's comfort level with
current valuations and whether he perceives any opportunities to further add on
to positions or to switch out of less attractive positions to more attractive
ones. My recommendation is to never be fully invested (i.e. 0% cash level) as
this means that you would not have any ammunition to average down should there
be a market crash or severe downturn. Bear markets are a separate topic
altogether which I will do a blog post on some other day, but note that bear
market or not, it is always important to keep some cash handy as an
"opportunity fund" (note I have indicated this in my monthly portfolio
summary), ready to deploy when valuations become attractive.
Conversely,
cash levels which are too high (I would say in the region of 30% to 50%) would
suffer from "cash drag" and lower overall returns for the investor,
as it would mean that cash is not deployed in the most efficient manner to
generate returns for the investor. Some investors may prefer to sit on a
mountain of cash as it brings them comfort because they are always worried
about a crash coming round the corner. The sweet spot, I feel, would be a cash
level of around 5% to 10% (of course, this depends on the absolute value of
your portfolio - a $10,000 portfolio may be just starting out and you may have
another $10,000 to deploy, in which case it is "forgivable" to have a
cash level of 50% ($100,000 over $200,000)). This is to ensure you have enough
firepower for averaging down on selected attractive positions, while also not
letting too much of the cash rot away in a bank account earning close to zero
returns.
Portfolio Management
Now that I
have briefly discussed on portfolio construction, it's time to look into the
equally important aspect of portfolio management. By "Management", I
refer to how one should continually monitor and keep track of the portfolio,
much like the way a gardener keeps track of his young saplings or mature crop.
Using the plants analogy, a portfolio is something which you need to grow,
water and nurture so that it will perform well, and also save you lots of
heartache in case any position suffers a blow-up.
Monitoring and Assessment
Monitoring is
an essential feature of any portfolio and the astute investor should spend
sufficient time and effort to keep up with the financials and business outlook
for the companies he has invested in. At the very least, reviewing and reading
the quarterly statements, press releases and presentation slides should be
mandatory; while also reviewing any periodic or ad-hoc corporate announcements
concerning M&A, contract wins or other pertinent newsflow. Assessment here
would relate to assess news and articles on an on-going basis in order to
ensure one is kept abreast of the latest developments within each industry
which affects his investments - this may seem daunting as there is a lot of
information to track and read daily, but the investor should learn to filter
out unnecessary noise in an intelligent manner and also to ensure he can
speed-read and scan headlines for news which is deemed more important. In that
way, he can maximise the use of his time and not fall into the trap of
"analysis paralysis" - being swamped with too much information!
Re-balancing
Re-balancing
refers to the act of trimming certain positions or adding on to others, or to
sell away some positions in order to add new ones. In a nutshell, it means
making changes to your portfolio on an on-going basis. For myself, I do not
feel much need for re-balancing unless my investment thesis gets invalidated,
in which case I would need to sell one of my investments (e.g. in the cases of
MTQ, SIAEC and The Hour Glass). Otherwise, it can be a case of just adding on
to positions when they become suitably attractive, thereby increasing your
stake in that position.
The investor
needs to re-calculate his exposure upon any exit or entry (or addition to
existing) to ensure he does not violate any of the rules he set out in his
investment philosophy. An example would be not adding more to a position if it
means exceeding a threshold of say 10% of the portfolio. Another option is to
allow the limit to be exceeded temporarily but to slowly add to other positions
in order to dilute down the weightage of that position to a more manageable
level.
There are many
different ways to re-balance a portfolio so I will not go into too much details
as this is very personal for each and every person, but suffice to say this is
an exercise which should be carefully thought out and even modelled (yes, in
Excel!) before it is done, as it can have repercussions on performance and also
margin of safety.
Optional: Updating intrinsic values for all major
investments
This is an
activity which the investor can choose to do should he have sufficient time.
Once the latest financials are released or information provided on certain
actions or strategies for the Company, one can re-assess and re-compute their
intrinsic value for the Company. This is to review each position to see if the
risk-reward ratio has changed (for better or worse) and to decide if
re-balancing is needed, or if there is a need to sell to raise cash levels for
a more attractive opportunity.
Conclusion
Constructing a
robust portfolio is a time-consuming affair and the investor should be mindful
that it can only be done with a lot of patience, study and also experience
(i.e. making mistakes). The idea here is to start off with a few investment
ideas and slowly curate the portfolio as one evolves and crystallizes one's
investment philosophy. This should obviously be an iterative process as
portfolios are dynamic and should not be stagnant or be perceived as static, as
businesses are also changing and evolving daily. The above pointers should
serve as a useful guide for anyone who wishes to start a portfolio but does not
know the various aspects to consider.
Stay tuned for
Part 3 of the Kingsmen analysis coming up in my next post.