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.

Averaging Strategies

Averaging strategies are commonplace in the world of investing (and trading). The two straightforward averaging approaches are “average down” and “average up”. If you do not know what are the ups and downs, here is a brief introduction to these terms.

Average Down

According to Investopedia¹, the definition of average down is:

The process of buying additional shares in a company at lower prices than you originally purchased.

This averaging strategy is usually used by investors (and traders) when the price of their shares (and other financial instruments of other asset classes as well) goes below their original purchase price. By buying more of the shares at the lower price, the average price of the entire holding would be lower than the original purchase price.

For example, I had bought 100 shares of ABC Company at $1.00 each, totalling $100.00. A few months later, the price had gone down to $0.80. I then bought another 100 shares at $0.80, making it $80.00. In all, I have 200 shares of ABC Company worth a total of $180.00 ($100.00 + $80.00), or $0.90 per share ($180.00 / 200), thus averaging down from my original $1.00 position.

There are a few reasons for this averaging down. One of which is to bring the average price to a level where it is “nearer” to the current price, thus making it “easier” to exit at that price (quoting the above example, it is “easier” for a share price to go from $0.80 to $0.90, than from $0.80 to $1.00; do note my quoted easier, however). Another reason is the investor could buy the shares on the cheap.

Average Up

Average up is the opposite of average down, where it is the process of buying additional shares at higher prices.² Using the ABC Company example again, I had bought 100 of its shares at $1.00 each, totalling $100.00. A few months later, the price went up to $1.20, during which I bought in another 100 shares, paying $120.00. The average price now would be ($100.00 + $120.00) / 200 = $1.10 per share, averaging up from $1.00.

Investors typically use averaging up when they see there is a potential for a particular share to go further up, therefore adding more positions to it.

Are These Strategies Good for The Bedokian Portfolio?

There is nothing wrong with averaging down or up; a form of this strategy is being recommended for index investing³ in The Bedokian Portfolio. Also, in my previous blog post on rebalancing woes (see here), one of the solutions proposed is to add positions to current holdings, which will definitely involve some averaging down or up. Whether up or down, especially for individual equities, bonds and REITs, fundamental analysis⁴ and the selection guidelines⁵ must be adhered to.

1 – Investopedia. Average Down. http://www.investopedia.com/terms/a/averagedown.asp (accessed 29 Sep 2016)

2 – Investopedia. Average Up. http://www.investopedia.com/terms/a/averageup.asp (accessed 29 Sep 2016)

3 – The Bedokian Portfolio, p 60 & 122

4 – The Bedokian Portfolio, Chapter 11 – Fundamental Analysis

5 – The Bedokian Portfolio, Chapter 12 – Selection and Selling

Rebalancing Woes

Rebalancing is the act of bringing your portfolio back to its original allocation, therefore reducing your risks through diversification. It also helps to sell away good performing asset classes and buy in non-performing ones.¹

However, there are some occasions where it is a bit difficult to do rebalancing. The main reason for this is there is nothing in the non-performing asset class to buy in. For example, you needed to do rebalancing between equities and REITs. You have identified which equities to sell, but you cannot find any from the REIT side.

Still, rebalancing has to be done. You do not want to get caught out with an over-allocated asset class. To address the “rebalancing woes”, check out some of the recommended methods below.

Relooking at Current Holdings

The easiest option would be to add positions to your current holdings. At least there is some familiarity involved, since you need not go around looking for new ones, as long as your fundamental analysis of the holdings is still in the healthy range (come to think of it, if it is not in the healthy range, it would be sold off).

Exchange Traded Fund (ETF)

ETFs are another good way to address the issue.²  However, not every index out there is followed by an ETF. At the moment the S-REIT ETF is not available yet, so this method may not work well for the above example.

Temporary Withdrawal of Cash

During rebalancing, the asset class that gets increased temporarily would be cash. If no rebalancing is done, you would have a higher-than-allocated cash component, and this may cause a little problem to your ideal allocation. It would be prudent to move the excess cash out so that The Bedokian Portfolio goes back to the planned allocation. To do this, however, would “stunt” the growth of your Bedokian Portfolio, since the portfolio size is reduced and the “compounding magic” delayed. Good thing is, the withdrawal is temporary, and the cash amount withdrawn could be deployed in the next rebalancing schedule, which by then the economic situation may have changed and you would have more suitable choices to buy in.

1 – The Bedokian Portfolio, p 80

2 – The Bedokian Portfolio, p 122

Retail REITs – One interesting way to analyse

The three important attributes of a property, as the adage goes, are “location, location and location”. Especially for retail properties, this adage holds true.

For my analysis of retail properties, specifically in the context of REITs, I would expand the “three locations” into something more detailed; the location of influence, the location of competitors and the location of complements.

Before we begin, let us take out a map, and we use the Singapore map for reference, since we are more familiar with the local retail properties here. Next, on each of the retail property the REIT owns, draw a circle with a one kilometre radius.

With this circle(s) in place, we could clearly use the “three locations” for our analysis.

Location of influence

Back in our geography days, we had learnt something called “area of influence”, where a certain shop services a particular area. The location of influence is similar to this concept, and the circle on the map denotes the retail property’s potential visitors and consumers. The more concentrated the visitors/consumers is, the better the chance of the retail property being visited, ceteris paribus. A good example of a good concentration would be the property mall located within a dense residential area.

Location of competitors

If there are other retail properties within the circle (and also those which are outside of the circle but close to its borders) and they do not belong to the retail REIT concerned, these would be deemed as competitors. This means the visitors/consumers from this circle would have choices of visiting either the property in your analysis or somewhere else. However, do conduct further analysis on these competing properties to see if they are strong ones or not.

Location of complements

Other than competitors, there are also complements which may help the retail property in question. A good complement example would be the MRT station or bus interchange, where a retail property situated next to these would definitely bring in a high traffic of visitors/consumers. Another complement feature would be whether the retail property is situated along the tourist belt of Singapore (e.g. Orchard, City Hall, etc.).

The above presents one of the interesting ways of analysing retail REITs. Do take note of other factors (as described in The Bedokian Portfolio, Chapter 12 – Selection and Selling) before making the decision of transacting in the REIT.