Saturday, September 15, 2018

Portfolio Construction & Management


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 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.


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.


Sillyinvestor said...

Hi mW,

What are your thoughts on cut-loss? Being FA grounded, does it mean that if there is no seemingly news that might adversely the company or industry, u will hold the counter even if it drops 30percent?

In the same veins, assuming the thesis did not change, how do u decide if u accumulate, reduce etc..

Do u base these decisions purely on the analysis of company prospects and valuation and not the percentage gain or loss.

Musicwhiz said...

Hi Sillyinvestor,

Thanks for the questions. My thoughts on cut-loss would involve the situation in which the original thesis for buying gets invalidated, which means that after a careful re-examination, the risk-reward ratio does not make sense and I would have to divest. It could also be the case where there was something I missed in my original thesis and after admitting this, the investment no longer makes sense and I would have to divest it.

If there is nothing fundamental wrong with the Company, I don't see why I should not buy more if it drops 30% or even 50%. As was the case in GFC when valuations and share prices crashed, many companies turned out to be very good bargains as the baby was thrown out with the bath-water. Just make sure you choose companies with strong balance sheets and resilient cash flows which can tide them through a protracted crisis.

If the thesis does not change, and the shares are trading at depressed levels, I usually take my time to accumulate a position slowly, over a period of months or even years. I am still buying Boustead nearly 12 years after I first bought a position, and for Kingsmen, I am still buying 6 and 7 years after my first purchase.

For your last question, yes I base it purely on Company prospects and the future outlook in order to avoid anchoring bias.

Sillyinvestor said...

Thanks ... mW.

Very insightful. I initially wanted to ask when u decide to accumulate more when the price head south, I guess it returns to the concept of sizing and risk reward profile again.

Thank you. Nice to have a real investor to ask about pertinent qns that I always have.

Have a nice Sunday

Musicwhiz said...

Hi Sillyinvestor,

You're welcome and have a good Sunday yourself!