HOW TO STRUCTURE YOUR INVESTMENTS

HOW TO STRUCTURE YOUR INVESTMENTS


By Chris Williams

Allocating to different investment classes versus stock picking!

There are so many opportunities available today; it becomes increasingly difficult to make the right investment decisions.

Let’s have a look at the major asset classes, then move on to appreciate asset allocation strategies. You can check on where you are now relative to your risk appetite and get a better feel for perhaps where you should be!

The major asset classes are:-

• Cash

o Including fixed deposits, money market accounts

• Bonds

o Investment grade (Sovereigns and quality corporate names) or high yield (junk); short, medium or long-term; domestic or foreign

• Equities

o Global, regional, country, or industry specific

• Property

o Residential, commercial, retail, REITS

• Commodities

o Oil, grains, precious metals, etc

• Hedge Funds

o Specific strategies or Fund of Hedge Funds



You may hold individual equities or bonds, but the vast majority are held via unit trusts, mutual funds or exchange-traded funds (ETF’s).

Other asset classes include financial derivatives (mainly futures and options contracts, which give virtual access to dozens of markets with high leverage) and luxury goods such as art, jewellery, cars and yachts.

To put these asset classes into perspective, at the end of 2008 global private wealth stood at US$32.8 trillion – and growing. With all the noughts, that’s US$32,800,000,000,000 – a lot of money in anyone’s book.

Pension funds, mutual funds / unit trusts and insurance assets totaled US$61.6 trillion, with private wealth accounting for about a third of that figure.

Real estate assets were US$11 trillion, hedge funds US$1.5 trillion, then private equity and REITS around US$1 trillion each.

Asset Allocation

Asset allocation is based on the idea that in different periods, different assets will perform better than others. It is easy to see why some investors will swap and change their holdings according to whim – but that strategy could easily end up with much worse results than by adopting a consistent approach.

The key is that different asset classes offer returns that are not perfectly correlated. Therefore, by diversifying investment classes, the investor is reducing overall risk for a given level of expected return.

A great deal of academic study has been done on this subject, and it explains the importance of asset allocation and the problems of active management. This explains the steadily rising popularity of “passive” investment styles (buy and hold) using index funds.

Making decisions on what percentage of your investments should be in any one class will ultimately depend on your appetite / aversion to risk. Simply buying stocks without regard of a possible bear market can result in panic selling later. Your true risl tolerance can be hard to gauge until you have experienced a real bear market with money invested in the market.

Projected 10 year Cumulative return after inflation

(stock return 8% yearly, bond return 4.5% yearly, inflation 3% yearly

80% stock / 20% bond 52%

70% stock / 30% bond 47%

60% stock / 40% bond 42%

50% stock / 50% bond 38%

40% stock / 60% bond 33%

30% stock / 70% bond 29%

20% stock / 80% bond 24%

Source: Bekkers Niels, Doeswijk Ronald Q. and Lam Trevin W., Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes , Journal of Wealth Management, Vol 12, No 3, pp 61-77, 2009

The table shows why asset allocation is important. It determines an investor's future return, as well as the bear market burden that he or she will have to carry successfully to realise the returns. This is over simplified, of course, as your portfolio is likely to include other asset classes as well.



Asset allocation decisions, as opposed to specific fund or stock choice, and market timing, are the driving force behind well structured investment portfolios and returns.

Finding the proper balance is key – which is a great reason to seek professional advice.

[The author is Senior Investment Advisor with Meyado Private Wealth Management Pte Ltd in Singapore, and has over 40 years experience in financial markets]