Investment Approach : Building Your Portfolio Using ETFs

Investment Approach : Building Your Portfolio Using ETFs

Philosophy


My aim is to help you to earn the highest return possible on your investments, while also protecting your hard earned money. 

Most investment professionals only provide their clients with a combination of stocks, bonds, and mutual funds. We believe there is a better way. There was a time when this traditional approach was appropriate, however the investment world changes constantly and with it new tools and strategies are becoming available that help you protect your money, while also directly investing in many attractive Indian or global opportunities. Given the current condition of the Indian market, this is especially true today.


The idea is to consider all asset classes including the traditional strategies of using stocks and bonds, but also commodities, gold, currencies and real estate. 

While it is commonly accepted within the investment industry, it isn’t widely communicated to clients; stock picking is not a big contributor to your total return. In fact, stock picking (or security selection as it is referred to within the industry) only contributes about 5% to your total return. Yes, this is somewhat important but not nearly as important as the other 95% of your return which comes from the asset allocation decision. As a result, your investment approach must focuses first and foremost on ensuring your portfolio has the correct allocation to each of the major asset classes. This allocation is determined by your specific investment objectives; as it is your objectives that determine exactly how much of your money should be invested in each asset class. 

Since everyone is different and has different specific goals, one must construct your portfolio specifically for you and not offer "off the shelf" products or strategies. You are not a "balanced growth client." You are unique and your investment portfolio should be as well. 

Asset Allocation 
The approach to the Asset Allocation decision focuses on a thorough analysis of the global economy with specific focus on market specific indicators. Our patience and our experience has taught us that all asset classes become significantly mispriced at one time or another. An objective mindset guided by liquidity, earnings, technical and sentiment indicators help to identify periods when mispricing occurs. It is during these periods of mispricing we must capitalise to benefit your portfolio. 

Exchange Traded Funds 
One of the best method to construct our investment portfolios are by using Exchange Traded Funds (ETFs). An ETF is an investment vehicle which is constructed like a mutual fund but trades like an individual security on a stock exchange. ETFs provide instant investment across all asset classes including stocks, bonds, gold, commodities, real estate and currencies. With almost 2000 ETFs in the world today and growing, they are amongst the fastest growing　investment vehicles because they provide a compelling combination of low costs, performance, diversification and tax-efficiency. 

Low Cost
ETFs have a cost advantage on average of about 1.5% relative to actively managed mutual funds. This cost advantage has a significant impact on a portfolio's performance over time.　 Fortunately costs are among the few controllable variables in a portfolio's returns and ETFs provide an opportunity to enhance your net returns by reducing your investment expenses.

Performance
When you invest in a mutual fund, you are asking the manager to make "active" decisions so that your return will be better than that of an index or benchmark. The index or benchmark is called a "passive" investment and is easily available to all investors through ETFs. Unfortunately for active managers, few are able to consistently produce returns greater than their benchmark over the long term. In essence, most investors are not only paying excessive fees within their mutual funds, but they are also paying for lower returns than what they could otherwise achieve through passive investments in ETFs. ETFs address the problem of benchmark underperformance by actively managed mutual funds.

Diversification
ETFs allow investors to　gain exposure to an entire asset class　with　a single　security, thereby avoiding the risks of owning individual stocks. ETFs own most or all of the securities that constitute an index, and exact portfolio holdings are disclosed on a daily basis, providing full transparency.

Tax Efficiency
Tax efficiency is a critical issue that is often overlooked by investors.　 Delaying the taxation of appreciating assets　significantly enhances after-tax returns over time. ETFs are among the most tax-efficient securities due to their low internal portfolio turnover and their unique method of creating and redeeming shares, which allows　the ETF manager　to continuously purge the lowest-basis tax lots from the portfolio.　 As a result of these factors, ETFs are able to minimize, and in most cases avoid altogether, the taxable gain distributions that have created unwanted tax liabilities for investors in actively-managed mutual funds.

Your investment manager should not have any obligation or proprietary affiliation with any specific ETF provider. As an independent manager, he must choose ETFs from a broad spectrum of offerings that meet the criteria of your investment objective and hence the process, strategy and outlook.

Strategies
Stocks 
The objective of investing in stocks is to provide growth of your capital over the long-term. Stocks represent a percentage ownership in a company. After a company has paid its expenses and creditors, any earnings left over belong to you. As a stock holder then, it is important for the company to be successful in growing its business and that it remains profitable - simple enough.

The World however is always changing. Change means new opportunities for some companies, and major threats for others. A few years back when investing in international markets started to become popular, the focus was on different regions or countries. Little thought was dedicated to the economic sector or industry on a global basis.

Today however increased globalisation, more sophisticated capital markets, and the emergence of the middle class in developing countries make the sector and industry decision even more important to your total return. With this in mind, it imperative to have an approach that is both global in nature as well as regional and flexible enough to recognize that opportunities that exist on a global nature as well to our country or region in isolation to everyone else. As such, our view of the World is one that sees not only different countries and economies, but one that consists of 10 major economic sectors, with each one being strongly influenced by global economic cycles, interest rates, as well as local consumption trends.

Hence the approach to managing stocks should therefore be highly focused on both regions as well as economic sectors. To assess the relative attractiveness of a region and sector, we can rely upon two different models consisting of external factors and internal factors. The external factors assesses economic conditions, real money supply, OECD leading indicators, short-term real interest rates, and long-term interest rates. While internal factors assess earnings yield momentum, stock price momentum, and market breadth indicators. Together, this disciplined and unbiased approach identifies not only the attractive areas to invest your money, but also areas to avoid.

Bonds 
The objective of investing in bonds is to provide: 
1) provide a constant stream of income and 
2) provide stability to offset the fluctuations inherent with other parts of your portfolio

In its simplest form, a bond is a loan to a company, or government. In exchange for you lending them money, the company or government promises to make regular interest payments to you as well as to fully repay the loan at a specific date in the future. Some bonds have maturities for as short as one day, while other bonds have maturities for as long as 30 years from now. Depending on the terms of the interest payments and maturity, as well as the credit worthiness of the borrower some bonds will pay (or yield) more or less than others.

Though your bond strategy can cover all global regions, and corporate sectors, however the primary focus for you should be on your domestic market.

With that in mind, we must use our bond strategies as defensive positions, one that is meant to protect your wealth. Duration or maturities will be rather short-term in nature, and credit risk will focus primarily on government, sovereign, and high grade corporate bonds.

The key inputs into our fixed income strategies include a thorough analysis of the economic cycle, inflation expectations, and credit conditions. The composite outcome from all parameters provides guidance as to how the fixed income strategy is to be positioned within your portfolio.

Commodities 
Commodities offer long-term returns similar to that produced by the stock market. However, what is special about commodities is that collectively they have a low correlation to stocks, bonds, currencies, and real estate. This is valuable to you because when commodities are added to your portfolio, their low correlation attributes help to actually reduce your overall investment risk.

Strategies focus on the main commodity groups including Energy, Agriculture, Base Metals and Precious Metals.

Long-term trends in commodity markets usually run for 12-18 years, producing great opportunities for additional portfolio returns and diversification from stocks, bonds, currencies and real estate. Yet, these long-term markets also possess several smaller cycles that can last for several months to several years. The point being of course, nothing goes up or down in a straight line.

With this in mind, the commodity models should identify favorable trends by focusing on fundamental, economic, technical and sentiment indicators. Once an opportunity is identified the portfolio will consist of an ETF strategy of either a broadly diversified commodities, or specific commodity groups including Energy, Agriculture, Base Metals, and Precious Metals.

Gold 
When constructing investment portfolios, the ultimate objective is to structure a strategy that optimizes return while protecting your wealth. The addition of gold to a portfolio achieves this objective by significantly reducing portfolio volatility, while also maintaining expected returns. During normal economic cycles, gold performs in-line with a diversified commodity portfolio.

Yet, the real value of holding gold is even more evident during the following market environments:

1) Periods of US Dollar weakness, and other major currency crisis. Currencies are paper assets, issued with the backing of the underlying government. Gold is a hard asset that serves as the ultimate storage of wealth which becomes even more attractive during periods of any major currency crisis.

2) Low/negative real interest rates signal that inflation expectations are low and that a policy response will likely focus on reigniting inflationary pressures. Gold outperforms during all inflationary environments.

3) Deflation. The world has really only experienced one period of severe deflation (The Great Depression). Throughout that cycle gold outperformed all other asset classes. This really shouldn’t be a surprise because whenever there is increased uncertainty in the world investors automatically want safety – and gold is the ultimate store of value.

4) Heightened systemic risk. One side effect of a global market economy is asset bubbles. All bubbles eventually break, and gold has always preserved capital during these periods of systemic risk.

When global macro conditions become detached from the trends in gold prices, our strategy focuses on trader and investment sentiment, market technical’s, and seasonality factors. When assessed together, these factors are very dependable for identifying opportunities to invest in gold.

Currencies 
The allocation to currencies will normally compliment your cash and bond strategies with coverage including US Dollar, Canadian Dollar, Euro, British Pound, Japanese Yen, Swedish Krona, and Swiss Franc.

Differences between exchange rates is normally a function of inflation expectations, interest rate differentials, and the fiscal outlook for the respective countries. This holds true over the long run, however fluctuations and deviations between true values can exist for quite some time.

One must approach to the idea of managing currencies with consideration of the long-term fundamental values for each currency, but also utilize technical movements to identify opportunities when current values have deviated from their true long-term price. To achieve this we should focus on moving averages, momentum, and relative strength indicators.

Real Estate 
From an investment perspective, real estate is normally included in investment portfolios to provide a constant stream of income as well as to provide protection from inflation. Traditionally, institutional investors such as pension and endowment funds were the dominant investors in the industry. However, today opportunities exist for individual investors through the use of ETFs and the newly introduced REITs.

Having said that, we are cognizant that many individuals already have ample exposure to real estate through their primary residence and other properties. In addition, this is usually a significant portion of their total net worth meaning that additional exposure through their investment portfolios may not make sense.

Since every client is unique, real estate certainly shouldn’t have to be included in every portfolio. We must however appreciate, that normally real estate returns are driven by financing and regional factors, and there will therefore be times when it is appropriate for certain portfolios. In addition, during an economic cycle real estate does behave differently than other asset classes such as stocks, bonds, and commodities meaning there diversification benefits to including it in the portfolio. When it does make sense to include real estate in the investment portfolio, we can take help of professionals to utilize the tools and strategies available to provide optimal returns.


Happy Investing