As you head to the end of the year, it's time to re-evaluate your investment portfolio. It's when you own up to the bad moves or misses and give yourself a pat on the back for those that have provided handsome returns or perhaps just minimised losses.
Undertaking such a review essentially means taking stock of which types of assets and holdings you should sell, reduce, hold or buy.
Then decide whether to opt for small adjustments or go for a wholesale makeover to boost the performance of your portfolio and help you achieve your goals in line with your investment horizon, risk tolerance and personal circumstances.
Key factors to look at when carrying out a review of your investment portfolio include:
The kind of asset allocation: the mix of equities, bonds, real estate, alternatives and cash that will have determined whether the portfolio has met your targets.
"How assets are allocated between the major and minor asset classes, and the overall equity-bond mix, is a big predictor of return and risk," says Dan Dowding, senior executive office, Middle East and Africa, Killik & Co. Also, the asset mix, he points out, affects the yield or income a portfolio generates, and this is a key consideration for retirees and tax-sensitive investors.
Inevitably, diversification is an important concern as part of portfolio construction.
Correlations low
"It is important to assess how each of the assets will perform in a given scenario and ensure that they are not going to perform in the same way; in other words that the correlations are low," says Paul Cooper, managing director, Sarasin-Alpen Partners Ltd, Dubai.
But given the uncertain and volatile investment landscape, it could be prudent to seek diversification beyond the traditional allocations to stocks, bonds, real estate and cash.
"The new market environment demands judicious allocations in alternative asset classes, which may include precious metals, emerging markets, managed futures, currencies and fund of funds," says Krishnan Ramachandran, chief executive of Barjeel Geojit Securities.
"Allocation into these alternative asset classes has the potential to battle out the market vagaries and help investors to realise the much-needed incremental returns on their portfolios."
Of course, the size and mix of exposure to assets, including alternatives, will depend on the investor's risk tolerance.
For most of us, risk is generally associated with the possibility of losing money, says Peter Duke, head of sales at Fidelity Investments, Dubai.
Time frame
"Our appetite for investment risk is influenced by our time frame and goals. If we are saving for a deposit for a home, we are less likely to tolerate wild market swings."
Another factor to be considered when reviewing your portfolio is to look at the concentration of risk within the portfolio and the impact that this had on your return. The way to go about this review, says Dowding, is to analyse the spread of stocks among the various sectors and industries as a percentage of value of the portfolio and compare this to the overall market weighting.
For example, an index such as the FTSE 100 or ASX is heavily weighted towards financials and mining stocks and underweight in technology. An investor with a market weighting in these is betting heavily on a recovery of the financial sector and strong commodity prices, and betting against the technology sector.
Sector or industry sensitivity aside, how many stocks an investor has in their portfolio and what proportion of the equity allocation they represent determines "stock specific" risk.
Some investors, he notes, use managed funds, either active or passive in style, to introduce a diversified ‘core' exposure which minimises concentration risk. They then surround that with a ‘satellite' of market-beating ideas to generate what fund managers refer to as "alpha" (out-performance relative to an asset's assumed level of risk) and "beta" (essentially, the asset's historic volatility beyond the average market trend).
At the other end of the scale, he says, are some direct investors with too many small holdings that together account for less than 5 or 10 per cent of portfolio value. In either case, an investor should question how much value that assortment brings and "whether [there] is a housekeeping opportunity as part of the review process".
Individual holdings also need to be assessed in terms of how they add or detract, says Vince Truong, a US certified financial planner at Holborn Assets.
"The more volatile the [type of] asset the more important it is to drill down to the individual holdings," says Cooper.
The performance of a portfolio, especially over the medium and long term, should be viewed not only in absolute terms, but also relatively, that's to say compared to both the investor's target objective but also benchmarks for like-asset classes.
Performance, according to dowding, should consider a number of factors:
• Return versus volatility
• Return if the best and worst investment were removed (ignoring extremes
• Return if the largest holding were removed (for a broader sense of average returns)]
• Return over different time periods and business cycles — to assess the alignment of defensives versus cyclicals
• Risk and return versus the appropriate benchmarks
• Risk and return versus a different equity/fixed income asset allocation
• Turnover and the cost to run the portfolio
• Income versus capital growth
Still, one has to be careful not to over-emphasise stock market indices as the right benchmark for reviewing the performance of a portfolio.
This has been a year when headline news has driven the market and many active managers have been underperforming benchmark indices as they tried to manage the portfolio's risk in very volatile conditions, points out Truong.
"From a performance-only perspective, they may under-perform, but at the same time, they are managing how much risk their investors are exposed to. That is, they care about their investors but the benchmark index does not."
Exceptional circumstances require a particularly careful approach, with clients' money at stake. "If there's a systemic collapse due to the European situation, they can de-risk a portfolio and minimize losses."
Fund managers' charges can impact performance significantly. It's important, especially if an investor is using mutual funds, that they ‘get under the bonnet' of their funds and work out what they are paying.
Mirror fund
"Does the performance really justify the [management] charge, how does [it] compare with similar alternative [providers], and are there performance fees?" says Dowding. "Higher charges are justified if performance is strong, but eat into returns or exacerbate losses if not."
Indeed, is it a mirror fund, meaning that the investor may be paying fees essentially for an inactive, intermediary management?
Haissam Arabi, in the context of Gulf markets, points to the seasonal factors to consider when reviewing stock positions. "[The] January-February effect is always there and markets do go up then," he says. "This is the best time of the year to hold on to your gains — you don't want to lock in your profits or getting out of the markets early."
Reviewing bond portfolios could be tricky, especially for those perturbed by the Eurozone sovereign debt crisis. According to Ramachandran, the simplest strategy, especially in these volatile times, is to hold short term bonds with maturity horizon of one to two years. This way one can actively participate on various short term yield maturities which are certain in the near-term. On the longer tenure bonds, depending on the tenor and yields to maturity decisions have to be taken whether to hold or sell, he adds.
Factors like inflation, interest rate, maturity period have to be considered when reviewing bonds in a portfolio.
Volatility
As volatility increases, so does risk, and it is important for investors to ‘stress test' their portfolio.
"But stress-testing is no guarantee against losses, nor is it possible to model the impact of all scenarios," says Dowding. Indeed 2011 has been dominated by unexpected events — unrest in the Middle East and North Africa and the Japanese nuclear disaster.
Right now, he thinks, investors should model the impact that various "events" could have: a rise/fall in interest rates; higher/lower inflation, underperformance of the largest holding, and, more shockingly, a 50 per cent fall in the stock market, or collapse of the Eurozone.
"While it is difficult to accurately predict the real impact of many of these events on returns, and the likelihood of occurrence — the process will enable the investor to re-consider his or her tolerance to risk and perhaps consider implementing an appropriate hedging strategy," says Dowding.
