The 12% Limit

There was an interesting conversation on investments that I had with a friend of mine. He has a simple equity-bond portfolio and the weightage is 60-40 respectively. As we chatted on we started to go into the nitty gritty of his portfolio, and what he revealed next came as a surprise to me.

His portfolio is consisted of only two individual companies at the equity portion, and a corporate bond making up the entirety of his bond part.

  

When I asked him further on the choice of his components, he said he was familiar with them and deemed them as safe investments.

Risks

Using my friend's portfolio as an example, let us assume his two company equities are Company A and Company B, and the corporate bond is called Bond Z. The ratio of holdings between Company A, Company B and Bond Z is 30 : 30 : 40 respectively, based on his 60-40 allocation.

There are a number of risks inherent in his portfolio. First on the list would be bond default risk; the worst case scenario is a total default of Bond Z, and this would mean a 40% wipeout of his portfolio.

Next up is market risk; if the price of Company A goes down by half, it would translate to a 15% overall loss for the portfolio.

The doomsday scenario would be the complete price collapse of Companies A and B, and Company Z which issues Bond Z, during a market downturn. It did happen during the 2008-2009 Global Financial Crisis. That is a scary thought.

In fact recently some stable companies' share prices were taking a dive, and the default of corporate bonds were making financial news headlines in the past few months. The risks are real.

Diversification and the 12% Limit

This is where the importance of diversification comes in. As often mentioned in my ebook, diversification helps to reduce risks. By having more individual equities, bonds and REITs within a portfolio means the risks are spread across, and a collapse or default of one company or REIT would be less painful.

As a guideline, I would recommend that an individual equity/bond/REIT do not exceed 12% of the portfolio value. In the event of a wipeout, 12% would be the maximum loss you could bear.

Why 12%, you may ask.

I derive the 12% guideline from the holdings of the Straits Times Index, or better known as the FTSE STI. If you look at the factsheet¹, the three largest components are in the range of 11.xx%. So to round it off, I made it 12%.

Exceptions to the 12% Limit

There are a few asset classes and investment vehicles that are exempted from the 12% limit. Exchange Traded Funds (ETFs) are one of them; after all, they are made up of different individual equities/bonds/REITs/commodities. The only risk of concern would be the counterparty risk against the ETF provider, but that is low compared to the risks of holding Company A, Company B and Bond Z only. The others would be physical commodities (e.g. physical gold and silver) and cash.

Back to My Friend

I had told him basically what I had posted above. Good thing is his portfolio is still healthy at the moment, and he would be exploring other equities and bonds, as well as ETFs.

1 – FTSE Russell. Straits Times Index. 30 September 2016. http://www.ftse.com/Analytics/FactSheets/temp/dd0f6ae5-f886-423d-8b54-a35b1069b2eb.pdf (accessed 31 October 2016)

Passive or Active Investment

One good thing about The Bedokian Portfolio is that it gives you a choice to be either a passive or active investor. A passive investor would just look at his/her Bedokian Portfolio once or twice a year, do the necessary rebalancing, and off he/she goes until the next rebalancing cycle. An active investor (like myself) would keep tabs with the goings-on in the financial markets and rebalance his/her Bedokian Portfolio any time.

Whether you choose to be in the passive or active camp, here are some pointers that you could follow should you opt for either.

Passive Investor

As the passive Bedokian Portfolio investor looks at his/her holdings once or twice a year, the safest recommendation would be index investing through ETFs.

If you want to have additional yield and returns, and decided to add in individual equities, bonds or REITs, then select those with strong fundamentals using fundamental analysis, which I had described in Chapters 11 and 12 of The Bedokian Portfolio. Companies and REITs with strong fundamentals would have lower risk and thus you could afford to relook at them in the next rebalancing cycle without having to worry too much. Although this is not fully passive as you would need to conduct analysis, but it could be done during the rebalancing stage, to see if the equity/bond/REIT could be kept or sold off. To make things easier, you could also adopt a “core and satellite” Bedokian Portfolio¹ in managing your passive investments.

Active Investor

I had mentioned quite a bit about being in the active camp for The Bedokian Portfolio², and I want to specifically bring up the point about being connected often to the financial market information. This means you would have to read news and information on the economy, markets and maybe even individual companies and REITs at least once every few days in order to have a “feel” on the overall picture. Also, there is this issue with managing your transaction costs and not degenerating active investment into trading.³

The main gist of being an active investor is the interest of all things related to investment, like a hobby. You must see things holistically and with a macro view, so as to piece the various snippets of information together to form a picture.

So Which Is Better For Me?

The only person who could answer that question would probably be you. My take is; if you think your investment knowledge and time are limited, then passive may be suitable for you. If you think you are up for the challenge in managing your Bedokian Portfolio and an interest in the world of investment, then the active route may be the one.

1 – The Bedokian Portfolio, p 122-123

2 – ibid, p 93-94

3 – ibid, p 103

A New REIT ETF is Coming

It has been all over the local business news recently, with the impending launch of a new REIT ETF in the second half of October 2016. By now a number of financial and investment blogs would have talked about it, so I will just give my perspective on it as a Bedokian Portfolio investor.

Basic Information

The upcoming REIT ETF will track the SGX APAC ex Japan Dividend Leaders REIT Index¹, which is consisted of 30 REITs across the Asia Pacific region (except Japan).  From the product factsheet², 59.05% of the dividends came from Australia, with Singapore second at 29.62%. The ETF also has a total expense ratio of 0.65% and the dividends are to be paid on a semi-annual basis. It would be dual listed on the local exchange, in US$ and S$.

Application to The Bedokian Portfolio

The nature of the ETF somewhat epitomises The Bedokian Portfolio’s dividend and index investing nature (read: “Dividend Leaders”, “REIT” and “ETF”), since the mantra is “Passive Income Through Dividend and Index Investing”. The ETF could fill the gap for index investing within the REIT asset class, as there is currently none locally to begin with.

Also, with almost 60% of the dividends derived from Australian properties, it would be classified as a foreign component for The Bedokian Portfolio, in accordance to the guidelines.³  So if you have imposed a cap on foreign holdings, do take note.

Last but not least, caveat emptor, please do your due diligence and conduct further analysis before committing the transaction.

1 – SGX News Release, SGX launches SGX APAC ex Japan Dividend Leaders REIT Index, 29 Aug 2016. http://infopub.sgx.com/FileOpen/20160829_SGX_launches_SGX_APAC_ex_Japan_Dividend_Leaders_REIT_Index.ashx?App=Announcement&FileID=419211 (accessed 9 Oct 2016)

2 – Philip Capital Management. Phillip SGX APAC Dividend Leaders REIT ETF, Oct 2016. http://www.phillipfunds.com/uploads/funds_file/Phillip_SGX_APAC_Dividend_Leaders_REIT_ETF_Product_Info_Sheet_ipo_USD.pdf (accessed 9 Oct 2016).

3 – The Bedokian Portfolio, p 111.