By Ben Fok
CEO, Grandtag Financial Consultancy (S) LAST week, I was having a chat with Peter who was very depressed with the performance of his unit trust portfolio. As a self-taught investor, he has applied many investment strategies such as diversification, asset allocation, rebalancing and even dollar cost averaging. When I analyse his portfolio, I realised that his portfolio is well diversified across asset classes, countries and managers. Furthermore, he rebalances his portfolio once a year to keep his overall portfolio risk relatively constant. Financial advisers often advise clients to adopt these investment strategies. Unfortunately, Peter's portfolio could not withstand the financial turmoil and has declined by more than 59 per cent compared with a year ago. Peter is now frustrated and wonders what to do next. The current state of the financial markets is highly volatile and difficult to predict. The recent failures of some structure products are a testament to this tumultuous market. Having been in the financial industry for more than 20 years, I have observed investors' behaviours during times like this. I hope that by explaining why investors behave in a certain manner, you will be able to consciously identify some of these behaviours and better manage your investment decisions. In Peter's case, I agree that his portfolio is well diversified. However, diversification serves only to minimise risk. Consider two types of risk that our investments exposed to - systematic risk and non-systematic risk. Systematic risk (also called market risk) is a type of risk that is inherent in every market. In general, risks of this nature include interest rate, inflation and currency risks. It also includes events like Sept 11 and the current financial crisis which impacted all major markets globally. It is impossible to completely avoid this type of risk. The second type of risk is non-systematic risk. This includes company specific financial risk, management risk and industry risk. Fortunately, this type of risk can be eliminated by investing in a diversified portfolio consisting of companies across industries and markets. Researchers have found that people feel the sting of loss twice as acutely as they feel the pleasure of gain. Many investors often make investment decisions by taking into account the latest possible market information. The financial media, through televisions channels and news print, are devoted to the financial markets worldwide, 24 hours a day, and seven days a week. In recent times, almost every piece of news you read or hear is bad news. Companies are announcing job cuts and forecasting lower revenue. At the same, more people are facing credit problems and bankruptcy is on the rise. The world economy is slowing down and recession has begun in most countries. This news will inevitably cause investors to focus on losses and promote a tendency to evaluate and analyse their returns frequently. Simply speaking, investors tend to focus on losses rather than take advantage of potential investment opportunities. But how do the wealthy react to losses? Do they bury their head in the ground and be disappointed? We know that this crisis affects everyone, but what is important is how we react to such losses. We know that even the super rich suffered paper losses this time round. This includes well-known investors like Bill Gates who lost US$3.2 billion, Warren Buffett who lost US$5.29 billion and Li Ka Shing who lost about half his wealth. On the contrary, instead of focusing on losses, they are investing even more. What about Sovereign Wealth Funds? (SWFs are state-owned investment entity with the mandate to invest country's assets) As reported in the papers, in October 2008, $16.4 billion in market value was wiped off from Temasek Holding's portfolio. This is based only on 12 Singapore-listed companies that Temasek has significant stake in. Hence, it is evident that almost everyone who has invested in equities is affected this time round. Peter should not be too disappointed with his portfolio performance because no matter how much he diversifies his portfolio, it is difficult to be insulated from the negative global impact. Peter must also note that investor never make money when you buy; you only make money when you sell (at the right price). On the same token, investors never really lose money when the market is down; you only lose when you sell (at a loss). Another observation is that people tend to focus on the performance of individual component such as specific unit trust, rather than the overall portfolio. Investors should aim to pursue an asset allocation aligned with their risk appetite. The investment decisions made should be targeted towards the long-term horizon. A well-diversified portfolio does not mean that the every component will perform well all the time. It is more important that the overall portfolio returns are consistent during good times and bad times. Hence, components of the portfolio should have little correlation with one another. However, most investors want each and every stock of their portfolio to give superior performance all times. This is not a realistic expectation and can result in 'chasing the hot sectors' behaviour. I frequently ask my client: 'Can you tolerate seeing somebody else's portfolio doing better than yours?' I remember a client whom I helped to develop a balanced portfolio. I laid out a careful plan for my client by splitting his investment assets into four categories: domestic equities, domestic bonds, international equities and international bonds. This client understood completely what we were wanted to achieve with a balanced portfolio. In the middle of 2007, he called me up. He was quite upset that his investments were under-performing the Straits Times Index (STI). I thought to myself: With only 25 per cent of his assets invested in domestic equities, he could not expect the portfolio to outperform the STI. In fact, one reason why we develop a balanced portfolio was to make sure that it was less risky (volatile) than the STI. Nevertheless, I can understand his anxiety. Last few years have been great for domestic equities. The media has many times reported that the STI has hit an 'all time high'. My client feels that he was 'missing out' on the action. While this is an understandable reaction, this investing mentality is not very useful in making sound investing decisions. I have also observed that investors tend to believe that events are more predicable than they actually are. For example, looking at the past performance leads us to presume prior patterns will persist. If stock or other asset class did well historically, they will continue to be a star. Those that did not perform will continue to underperform. In Peter's case, the more he reads about the rise of China and India, the more he invests in China and India equities. Unfortunately, most of these markets are currently down. To overcome these mental biases, there are three ways that you can follow. Firstly, take note of how often you update yourself on your investment and how often you follow the stock market. Secondly, make sure that you invest with a long-term perspective and analyse your portfolio as a whole instead of its individual parts. Thirdly, seek out the opinions of other investor that you disagree with and see if these opinions have any merits. In conclusion, investor should not be under the misconception that investing in unit trusts is a cushion against risk. Today, the world stock market is generally in a bearish phase. There is very little that you can do if your investments were made just before the onset of the market downturn. However, it is important that you adopt the right investing mentality so that you can make more rational and wiser investment decisions. Don't focus on the losses. Instead, look for potential opportunities during this market lows. Remember what Warren Buffet said, buy when there is fear in the market. This article was first published in The Business Times on December 06, 2008. | 
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发表于 2008-12-3 17:55:12
