Many would have received advice from close friends or family members, or potentially even strangers about the importance of investing. This importance was emphasized, especially when considering one’s future, goals, and financial circumstances. In the broadest sense, investing should be thought of as a Decathlon where your portfolio should be able to perform optimally through multiple market events. Portfolio Optimization inherently is based on constructing one’s portfolio such that it can perform through thick and thin, through good and bad, through the ups and downs and the analogies go on. But, when developing a portfolio for investing purposes, it is important to clearly state what are the objectives of that portfolio. Is the portfolio mainly for Capital Appreciation, Capital Protection, Income Generation, or do I want a little bit of all? This week, we seek to highlight best practices when developing one’s portfolio in the context of asset classes and market-driven events. One should always invest holistically as the overall performance of a portfolio is hinged on the performance of its individual parts.
What Are the Different Asset Classes?
Broadly, asset classes are segregated into three distinct themes, namely, Equities, Fixed Income, and Alternative Investments. Each asset class has unique features that separate them from the other, but they are also affected by similar elements which makes them related. Equities (referred to as stocks) as an asset class represent an ownership stake in a public company. As an equity holder, you are highly exposed to the performance of a company as it transitions through the ‘business cycle’. Given that the business cycle fluctuates from peaks to troughs (like economies that experience a boom or recession), the value of your equity stake in the company changes in value. Cashflows are not guaranteed to equity holders and are highly dependent on the performance of a company to pay any cashflows (called dividends) after meeting all other obligations. These are the basic features of equities and why they are categorized among the riskier asset classes. When we refer to Fixed Income, for the purpose of this article, we will be referring to Bonds (as fixed income has multiple structures and variations). A bond is a debt instrument, like a loan, between a public company and the investor. Bonds are classified as fixed income because it is a contractual obligation that stipulates a stream of cash flows an investor is entitled to. Unlike equities, the cashflows an individual is entitled does not change with the performance of the company. This contractual agreement is a feature of a bond that makes it less risky relative to equities. Bonds are also tradeable, so if a company’s performance is attractive and they can service their cashflow obligations, other investors seeking to generate this level of cash flows may be willing to purchase this bond for partaking. Alternative Investments are a broad title that encapsulates any investable security that does not fit the bill of either equity or fixed income. Such alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment as well.
How Do I Prepare my Portfolio for a Decathlon?
How your portfolio is constructed should be guided by the goals of the portfolio. The combination of assets selected should both complement and hedge each other during different market events. In the current low-interest environment, bonds are an attractive investment option as there is an inverse relationship between interest rates and bond prices. Also, by making credit cheap, firms can raise debt at lower costs, which indirectly can improve return on equity (ROE) which benefit equity holders. When significant market events happen to shock the market, like COVID-19, there is contagion (the spread of an economic crisis from one market or region to another and can occur at both a domestic or international level) which affects all asset classes.
But, based on the assets in the portfolio, you can hedge the impact of such an event. Technology companies in the US are primary beneficiaries of the crisis, hence the reason the NASDAQ is up for the year (Year-To-Date: 8.74%). Companies that are best suited to weather this event will have revenue diversification, low leverage (low levels of debt), strong management teams, history of organic revenue and earnings growth. Domestic companies such as NCB Financial Group (NCBFG), Sagicor Group Jamaica (SJ) and Wisynco Group Limited (WISYNCO) are examples that meet these criteria. For fixed-income securities, countries that have diversified economies and strong fiscal measures will survive this pandemic with levels of multinational support such as Jamaica (JAMANs), Dominica Republic (DOMREPs) and Panama (PANAMs). Barita offers Collective Investment Schemes (CIS) such as our Unit Trust products that allows an investor to participate in these securities both international and domestically through our Capital Growth Fund, FX Bond Fund and FX Growth Fund. By speaking with a certified financial advisor, you can start preparing your portfolio for the Decathlon that is the investing.
Written by Haughton Richards, FRM, Senior Research Analyst
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In the broadest sense, investing ...
In the broadest sense, investing should be thought of as a Decathlon where your portfolio should be able to perform optimally through multiple market events. The combination of assets selected should both complement and hedge each other during different these market events
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