At this moment, I am trying to write this short article to support the case for geographic portfolio diversification. How it all came to this? Well, I wonder about it sometimes, too. It wasn't so long ago that I was this naïve kid fresh out of college with no care in the world. Ten years or so since that event, I was sitting in a café with one of my friends from my college days chatting about the state of investments in our country.
We talked about a lot of things, but the focus of this topic finally settled to the types of products, or rather, the lack of it in the domestic market. Without much ado, let's get to the point of our discussion, shall we?
Let's start with our investment portfolio - what is in it? If memory serves me right, most of us would have a% in fixed deposits, b% in mutual funds, c% with EPF (let's hope our nice employer did contribute their proper portion, too), d% in stocks, and e% in cash, and if we are so lucky to have put ourselves in debt or mortgage, a nice little apartment with a nice address tacked to it.
So, what is this investment portfolio for, anyway? The much needed retirement fund? Or a college fund for our kids? What about that fund for the much-longed-for Porsche 911?
And if I am not mistaken, most of us should be at this very point of our lives by the time we are 30 years old, give or take 2-3 years (let's keep those born with a silver-spoon in their mouth out of the equation, shall we?).
Now, if you can plot a chart of your total investment portfolio value, for the past 3-5 years, it should fall within the average range of 10%-12% per year. If this is not the case, you might want to consider giving your portfolio manager the "finger."
So, why 10%-12%, you might ask. Well, for starters, the benchmark for the stock market in a developed world, i.e. US, UK and most of Western Europe, have on an empirical basis been within the said range since their inception. Obviously, there are ups and downs over the years for these benchmarks, be it the FTSE 100, S&P 500 or DJIA, but their performance on average will fetch an average investor 10%-12% per annum. Guess why our esteemed professors always seem to stick with the prescribed 10%-12% rate of return in our Net Present Value of Cash Flow in the classroom.
It's definitely not just because the number 10% is a nice, round, (and fat) number; it's also quite interesting how this number seems to be a rather frequent occurrence throughout history. Anyway, that's another story to be discussed in a different post.
Investment Portfolio's Risk-Return - Basics for the Laymen
Alright, back to economics 201 - dealing with the risk-return subject. If we pay attention during our Financial Management / Corporate Finance classes in college, the RISK associated with investment portfolio A of a said component of investment products that fetches x% per annum return over time MAY NOT be the same as the risk of investment portfolio B, even thought investment portfolio B is fetching the same x% per annum.
"Why do I make such an illogical statement?" you ask. Well, is it?
What if investment portfolio A limits its investment exposure to stable countries like US, UK Western Europe and Australia, and generating a 12% per annum rate of return? Compare that to investment portfolio B that returns the same rate of return, and yet invests in riskier emerging market economies.
Wouldn't you say that the risk associated with the rate of return for 12% per annum is higher for B compare to A?
Many measures of risk-return have been devised by various statisticians and baffled many a students in the subject matter. Moreover, the subject is still open, and will possibly continue to be open to debate in the near future.
However, in the practical world, the industry has comfortably been using the Sharpe ratio and Traynor ratio for this sole purpose.
Well, enough of the educational part of this article. For those who are interested in this subject, I would recommend you check out you local Borders book store for a copy of The Handbook of Corporate Finance: A Business Companion to Financial Markets, Decisions and Techniques (FT-Prentice Hall) by Glen Arnold
To The Domestic Investor - Are You Diversified?
So, back to our main point of this article that focuses on 3 main questions - is the risk of our (domestic) investment portfolio too high? Can we improve our investment portfolio's risk-return profile? And how do we do it?
Consider the stocks in the stock exchange available to the regular domestic investors - Petronas, Sime Darby, Maybank, TNB, Genting, YTL or Maxis. All are very well-run, profitable companies and it is very possible that most of them have international exposure, i.e. exporter of goods and services. However, consider the risk exposure here.
Some of you might say the KLSE's indices have been outperforming the US, UK and other well established markets. So, why all these fuss is all about?
To that, I would just like to point out the good old days right before the 1997 crisis.
I am not sure if anyone else can recall the 1997 Asia-related economy crisis in detail, but I know if you held stocks in the companies listed in the KLSE (Main & 2nd Board), you will most likely wished you had held on to your cash in the bank; remember how long it too the KLCI to get back to it's pre-1997 level? If I am not mistaken, it took more than 5 years (editor, please correct me if I am wrong).
That means the regular domestic investors have to survive on sardines and crackers for the length of 5 years before we got back to the boom-days!
The point here being - you must never put all your eggs in one basket. The fact that your investments are all domestic-based proofs the point, despite the high-grade/quality of your investments.
So, what does all this have to do with your investments today? Guess what will happen if another Asian economic crisis occurs and all your investments are Asian companies?
Diversification is the key here. Besides, nobody can tell, the future, not even the great Sage of Omaha (although some who will disagree).
In a nutshell, the regular, law-abiding and ever vigilant, tax-paying citizen of Malaysia will probably be "investing" in - fixed deposits, mutual funds, selected stocks of the "best" domestic companies and maybe, manage to get indebted for one or two real estate properties; despite all their best efforts, they will not be truly diversified.
Now, if you are convinced that your investment portfolio can be further diversified, please read on. If not, please feel free to stop here since I do not wish to take too much of your time in reading any further.
Diversification - the "How"
Congratulations and thank you. You have finally realized the limitations of investments within the domestic market and taking the first step to diversifying your portfolio's geographic risk exposure.
It's like taking the little red pill in the scene from "the Matrix," doesn't it?
Anyway, please note that this is not a marketing scheme or propaganda to destabilize the domestic financial market (the status quo is doing a great job as it is).
What I would like to tell you now is no secret and it provides you with the possibility of re-aligning your investment portfolio from 100% exposure in the domestic market to maybe, say 15%-20% of your portfolio target.
There are various ways a non-US person (this means Malaysians, too) can invest in the US stock exchange market, principally, the NY Stock Exchange (NYSE) and NASDAQ.
The US Stock Market & Investment Products
Why the US Stock market? Well, I guess you can try the UK's FTSE (which is a very fine exchange), too. But the main reason I like the US stock market is the fact that the market is as well established and as well run, if not better, than the FTSE.
A bit of pro-US sentiments, you may add. But seriously, if you don't mind paying the brokerage fee in Great Britain Pound Sterling, be my guest.
Now, back to business, shall we…
The US Stock Exchanges - principally the NYSE, NASDAQ and to some extent, the American Stock Exchange (AMEX) offers a variety of product for the regular retail investor to diversify their portfolio, and at a reasonable cost., I might add
After all, international companies of unparallel quality like Procter & Gamble, Citigroup, Dupont, Johnson & Johnson, 3M, Cisco, Exxon-Mobil, Colgate, Clorox, Boeing, Monsanto, Google, Lockheed Martin, Pepsi, Coca-Cola, Hewlett-Packard, Apple, Intel, to name a few, are listed either on the NYSE or NASDAQ. Even well known non-US companies the likes of Cadbury-Sweeps, Danone, Toyota Motors, Sony, China Mobile, Novartis, GlaxoSmithKline, Nokia, BHP-Billiton, either as ADRs, or GDRs.
For the investors with a more conservative risk appetite, there are mutual funds and exchange traded funds (ETFs) that offer exposure to certain sectors - agriculture, energy, metal & mining, consumer staple, consumer discretionary, financials, etc. Or certain geographic regions - Euro-Pac, Latin America, China, Eastern Europe, all the way to country specific-linked ETFs.
The two notable ETF groups are SPDRs (managed by SSgA) and VIPERs (managed by the Vanguard Group); both the SSgA and Vanguard are very well established investment managers. Have anyone heard of John Bogle (retired) of the Vanguard group?
Oh! And don't forget options, too. Yes! The Joe Regular can options, too!
So, do take a moment and tell me if you want to restrict your investment portfolio to just Malaysian stocks?
Online Brokerage - Pro's & Con's
With the advent of online brokerage, it is now possible for the regular man on the street to "day-trade" and this has been the phenomenon that had spurred the growth of several discount brokerage companies such as TD Ameritrade, ShareBuilder, E-Trade and Scottrade, to name just four of many such entities in the US.
Secondly, the cost advantage - with the advent of internet revolution, cost associated with stock trading has been made more affordable. At an average of US$10 per trade (some goes as low as US$5 per trade), the reduction cost of stock trading has definitely spurred the growth of stock trading in the US.
The downside, of course, is the research. Unlike the full service brokerage, the discount brokers don't provide comprehensive research materials, e.g. analyst reports and updates.
That said, the internet evolution has erased or at least, bridged the gap here and anyone who has access to the internet and a computer can do their own research.
To Ali, Ah Kow and Rajagopal
Now, before you run out and print the application forms to open an online brokerage account, please make sure you do some research with regards the taxation implications of your actions. So, if you intend to start to go about some elaborate venture, you will very likely need to consult with a tax agent to ensure you are properly setup for such a venture.
Remember, the subject matter here never has anything to do with Tax Avoidance (perfectly legal) and shouldn't ever be associated with any dodgy Tax Evasion (totally illegal) activities.
Since our purpose is purely economic, I can safely say any Malaysian intending to diversify their investment portfolio can do so without much hindrance.
After all, the sole objective of this article is to inform and present the option to the readers that portfolio diversification beyond the local shores as a possibility for the investors to reduce their geographic risk of their investments portfolio, which at the moment (I am sure), is pretty much 100% exposed to the local environment.
Which is what I would like to introduce to you in a follow-up article by next month; I hope to get the article to you by the end of October 2007.
With that, I bid you adieu and happy researching until the next time.