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Flaunt Your Assets: Core Investment Portfolio

Jun 1, 2019 | 17m

Gain Actionable Insights Into:

  • Best practices for building a core portfolio that’s suitable for you
  • Evaluating and selecting ETFs and bonds when making investment decisions
  • The avenues and tools needed to get useful research that can help you make wiser investment decisions

Construct Your Portfolio

First of all, what’s a financial portfolio? It’s a grouping of financial assets that you choose to invest in. It can have both publicly tradable securities like stocks, bonds, futures and options and non-publicly tradable securities like private investments, venture capital, real estate, cryptocurrencies and art.

There are three key criteria to adhere to when constructing a portfolio:

1. The Portfolio Should Fit Your Investment Needs

As I’ve highlighted in my first book, Wise Investing, the most fundamental step should be that your portfolio fits your needs and your lifestyle. Your saving and investing activity should be something you can sustain your whole life and sleep tight at night. If portfolio construction is a new activity for you, then it is better to start safe and re-evaluate your risk profile later if you wish. Investing is as much a game of patience as it is a game of wits.

2. Diversification and Counter-Cyclicality

“Location, Location, Location” is a well-known proverb from property investors. Likewise, for financial portfolio it’s “Diversify, Diversify, Diversify”. Yet, just buying a lot of securities that carry the same type of risk is not good diversification. Aim for a portfolio that has some counter-cyclicality in it, which means that when one type of risk is triggered and that part of your portfolio diminishes in value, the other part of the portfolio actually increases in value or at least remains relatively unscathed. That’s why a lot of portfolios combine stocks or stock ETFs with high quality bonds. When the stock market corrects (falls), a high-quality bond portfolio will remain relatively stable and generate predictable income. Another example of good diversification is geographical diversification, which allows an investor to limit the impact to his or her portfolio due to, for instance, localised political events.

3. Analyse Your Biases

Biases are and always will be a part of our nature, however, it is crucial to understand their effect on our decisions regarding our investments. Like with any biases, there are limiting financial biases and empowering financial biases. An example of the former is home bias – a tendency to stick to investments in your home country, because for some reason they feel safer. An example of the latter is investing in sustainable businesses as research shows such investments perform better over the long run. Only you know which of your biases and beliefs are helping you and which are limiting you. However, one thing is certain: they require constant analysis.

I am not a proponent of hard written rules in investing because I believe that every investment portfolio is very individual. However, it is always wise to keep some guiding rules in mind.

Core Portfolio Rules

  1. Keep at least 80% of your portfolio in publicly tradable securities, that’s what we call a “core portfolio”. You can experiment with the rest. However, do so only if you have a specific reason to experiment. Otherwise, keep all 100% of your portfolio in publicly tradable securities.
  2. Keep your core portfolio in solid currencies that are strengthening, for instance, when a certain Central Bank or Monetary Authority is increasing their interest rates. In the near future such a currency will only be the United States Dollar (USD). However, please note that the relative strength of currencies changes over time.
  3. Keep a significant amount of your core portfolio in bonds unless you have a specific bias and a strong reason to do otherwise. You can use a classic 50-50 split (50% bonds, 50% equities), which works well for a lot of investors. Alternatively, you can use my business partner’s rule and use your age as a gauge for the proportion of the portfolio to keep in bonds. For instance, if you are 30 years old you could keep 30% in bonds.

Total Portfolio Rules

  1. Do not invest more than 10% of your portfolio into a single security or a single company, unless that security is a diversified index ETF.
  2. Do not invest more than 35% of your portfolio into a single sector unless you have a very strong reason to do so
  3. Do not invest more than 35% of your portfolio into a single geographical region, unless that region is a major economic block like the US.

Now that we’ve covered the key pointers, we will examine 2 of the most important tools that will enable you to build a high-quality core portfolio: ETFs and Bonds.


Evaluating Exchange Traded Funds

You may have heard of this term, or you may have even dabbled with it without really understanding it. Either way, I’ll give you practical steps to make better investment decisions within the world of Exchange Traded Funds (ETFs).

ETFs are funds that have been turned into a listed asset and are traded on an exchange. Most ETFs are listed on widely recognized exchanges like the New York Stock Exchange (NYSE) and therefore can be accessed via almost any brokerage platform. ETFs are designed by professional fund managers and generally follow a certain investment theme (investment declaration). The fund managers are then responsible for building and maintaining a portfolio that will deliver on the declared investment theme. Often, when we speak about ETFs, we refer to stock ETFs (ETFs that primarily consist of listed stocks, like QQQ). However, there are many other types of ETFs like fixed income or bond ETFs, gold ETFs and many more. For instance, one of the most popular ETFs in the world is SPY - the ETF by State Street Global Advisors that tracks the S&P 500 Index and contains stocks of some of the biggest companies in the world by market capitalisation. Another popular ETF is VOO (which is an alternative of the former by Vanguard Group). QQQ tracks Nasdaq-100 and is issued by Invesco.

ETFs like SPY, VOO and QQQ that track an index are commonly referred to as index ETFs. Index ETFs are created by large companies with sufficient skill and economies of scale. As a result, they are able to closely follow a certain index even in times of high volatility. They’re also affordable. The accessibility of individual ETFs will significantly vary depending on what exchange they're listed on. If your capital is below USD2 million, avoid exotic exchanges and stick to the large and liquid ETFs listed on established exchanges.

Not all ETFs are created equal. There are four crucial factors you need to look at when choosing an ETF: the ability to deliver as per the investment declaration, liquidity, size (Assets Under Management or AUM), and cost of the fund. There are ETFs that are superior in all four aspects whereas others will offer advantages in some aspects more than others. For instance, some ETFs could have an adequate amount of liquidity, have a substantial size, but be relatively expensive because they have a very unique investment declaration and they are good at delivering on it. A good example of such an ETF is BOTZ (Robotics & Artificial Intelligence ETF by Global X).

I’ve laid out some details on each of these aspects so that you can make more informed decisions.

Deliver According to the Investment Declaration

Can the fund manager deliver as per the investment declaration? You need to perform a high-level analysis of the fund manager’s ability to follow the investment theme of an ETF. For instance, if it is an index ETF watch how closely it follows the actual index.

If you are looking to buy QQQ – an ETF that aims to track the NASDAQ-100 index or NDX (100 largest non-financial, therefore mostly technological, companies listed on the NASDAQ) – then you compare the performance of the ETF to that particular index and look at how closely it correlates. This can be done on almost any brokerage platform or via Yahoo Finance’s full screen charts.

If it is a non-index ETF, look at the constituents (securities that the fund holds) and analyse how well they fit the fund’s investment declaration. Most ETFs will show at least their top 10 positions (holdings) by size. This will give you a good feel of what’s inside the fund.

Look out for Liquidity

After you’ve analysed the ability of the fund manager to deliver, you need to look at the liquidity of each ETF which is determined by its trading volumes. A good way to determine the liquidity of any security is to look at its average trading volume over a period of time. For instance, its Average Daily Volume (ADV), which is the average volume over 1 month and 3 months. When starting off, try to stick to ETFs where all 3 of these indicators are above 500,000 shares unless you have a strong reason to go below that.

If an ETF is actively traded (large volumes of it are being bought and sold) then you can get in and get out any time during trading hours. That’s why the liquidity of an instrument is essential for your risk-management practices.

As a rule of thumb, pick ETFs that have large amounts of data so that you can access the data volumes. If for some reason, liquidity data is not available to you and you need to make a decision, as a rule of thumb, the more assets an ETF has the more liquid it will be. So, in general, all ETFs with over 1 billion of AUM will have reasonable liquidity. However, aim to pick ETFs that have large amounts of data publicly available, so you can make an informed choice.

Watch out for Fees

As mentioned, investing in equity markets (or stock markets) via ETFs provides significant cost advantages compared to investing via equity mutual funds. This is the main reason why mutual funds underperform as compared to equities or stock.

To analyse the cost base of a fund, look at its expense ratio. This is the percentage of a fund’s assets that the fund manager is using to cover various fund expenses including management, administrative, marketing, compliance and various other operating expenses. Yes, they are using your money for this, so look at this number very closely. To give you a rough estimation, actively managed equity funds often have an expense ratio of above 1% whereas a lot of index ETFs have an expense ratio of below 0.1%. That’s a 10 times difference.

However, not all ETFs are that cheap. Before buying anything, look closely at the expense ratios, which are often publicly available. Choose the cheapest ETFs for the investment themes you are looking to pursue. However, before looking at the cost, shortlist ETFs with high quality fund managers who can deliver as per the investment declaration and which have sufficient liquidity. If for some reason, expense ratio data is not available, go for the largest ETF (the one that has the most AUM). Usually, the larger the fund size, the smaller the percentage of assets the fund manager has to use to cover expenses.

Give Priority to Index ETFs in Your Equity Portfolio

As of now our asset management company does not have any equity funds. Research shows that when it comes to stocks, active management in its classic sense doesn't work. Research shows that over 90% of actively managed equity funds underperform the indexes. The remaining 10% that do outperform the index change every year, so there is little consistency. Often equity mutual funds cannot offer an added return with their stock picking. They end up giving the same rate of return as the index, whereas their fees are much higher which results in consistent underperformance. Unless you have a specific niche expertise, I would recommend heavy use of index ETFs in your equity portfolio. So, if you have decided to allocate a certain percentage of your core or total portfolio into equity, whether it’s 5% or 50%, be sure to pick a nice basket of ETFs. Over time, that basket will outperform a large number of equity funds.

If you have no idea where to start, then the most obvious investment you can make is the S&P 500 ETF. There are various options for this like State Street’s S&P 500 ETF (SPY) or Vanguard’s S&P 500 ETF (VOO). These are great ETFs that should be in virtually any portfolio. You can evaluate them based on what I’ve shared above. It's a great investment tool that will outperform a lot of mutual funds and has lower volatility.

However, if you want to spice things up, you can add other ETFs that you have a bias towards. For example, if you believe that the technological sector will continue to grow despite the current fears in the market, then you can buy the Powershares QQQ ETF (QQQ). This will give you exposure to the largest technology companies listed on the NASDAQ. On top of that, if like me, you believe that certain sub-sectors of biotechnology like advances in gene therapy have a great opportunity for growth in the next 5 to 15 years, you can add an ETF that gives you exposure to that into your investment portfolio (for example VHT).

How you balance these is up to you, but the more you add sector specific ETFs like QQQ into your portfolio, the more volatile it may become. Make sure you follow good diversification habits and your investments fit your risk profile. If in doubt, stick to S&P 500 ETFs. All major ETFs can be accessed via an online brokerage account the same way you would access an Apple stock.

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Olzhas Zhiyenkulov


Paladigm Capital



Investing Intelligently