Monday, 6 June 2016

Core-Satellite Portfolio

Because belief in one's ability is not the same as actual ability

There are people who push a particular stock very hard and there are also overly bullish analyst reports (eg: STI Long term P/E is 15, but this stock P/E only 10 so price should increase by 50% so that the stock P/E is also 15 or something like that - this kind of analysis I also can do).

These people have strong belief. But strong belief does not equal to investing ability.

Many studies have shown that stock-pickers do not outperform the market.

One of the first lessons you learn is to treat stock recommendations from the internet with a pinch of salt. It is really not a good idea to ask for stock recommendations on the internet. At best, you follow the crowd (eg: the China craze before the crash). 

Taking things with a pinch of salt doesn't mean ignoring them totally. You should read analyst reports because there is always useful information in analyst reports, just take liquid paper and blank out their target price. (I think this is covered in some investing psychology textbooks).

Introducing the Core-Satellite Portfolio

Shiny Things in the forums advocates an ETF based portfolio since studies have shown that investors don't outperform the market. But stock-picking is interesting. How to balance the two?

As a compromise, you should have a core-satellite portfolio. The core being the STI ETF and the satellite portfolio which are your stock picks. The concept is so simple I hopefully don't need to say any more :)

The satellite portfolio can also reflect your interests. If you are a dividend investor, you would pick stocks that have higher dividend yield than the STI ETF. 

If you are into growth, you would pick growth stocks even though their yield is less than the STI ETF.

A little foreign exposure wouldn't hurt but that's made more difficult by SCB not have minimum commission. The compromise would be to look for local counters that derive most of their income from overseas. 

Bonds in your Core-Satellite Portfolio & Intelligent Rebalancing

Finally, you should hold some bonds. Shiny Things seems to be the lone supporter of holding bonds (he's releasing an e-book by the way, will update with his link when I have it) and I fully agree with him. Bonds will reduce volatility in the portfolio and also provide reserves that can be sold in case you need to rebalance during a crash. 

Eg: $10000 equities, $2000 bonds. If equities crash to $5000 and bonds increase to $2500, you would sell bonds and buy more equities to maintain the 5:1 ratio.  

Incidentally, this is a reason why the unit trust First State Bridge outperformed many 100% stocks only stock-picking investors despite the fact that it holds about 50% bonds. 

Intelligent rebalancing - when stocks are cheap, deviate slightly from the target 50/50 and go to 60/40 in favour of equities, when market recovers, sell off equities and reset to 50/50. Again, I don't know the full details of the fund's transactions but from their public information, this is what they did...

This is a mistake people make by dismissing unit trusts as no good, they also feel there is nothing to learn from unit trusts - I say, there is something to learn from unit trusts like First State Bridge which has delivered very good long term returns - which is their intelligent rebalancing strategy

Remember, the route to becoming a better investor is to have an attitude that there is always something to learn and not to ignore things you label as 'lousy' (unit trusts, analyst reports). 

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