Published: 2009/07/06
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The portfolio strategy of each investor depends largely on factors such as age, financial goals, life expectancy, risk tolerance and time horizon. These criteria would determine the exact asset allocation of different asset classes.
Generally, most investors would hold a combination of equities, fixed income and cash in their portfolios while the savvier ones may include property via real estate investment trusts and commodities. Regardless of the number of different asset classes, reducing the overall risk of a portfolio still requires diversification within an asset class, for example, by holding various industries to represent equity. This can be easily and cheaply done with exchange-traded funds (ETFs) and unit-trust funds.
ETFs and funds are investment vehicles that hold a basket of individual securities. This allows an individual investor to take a position in many individual companies or fixed income securities with one trade. It cost much less to buy units in an ETF or unit trust fund as compared to buying individual securities.
Although diversification is offered by ETF and funds, they are structurally different investing vehicles (refer to box). A key differentiator between ETFs and funds is the investing approach. Unit trust funds are actively managed by fund managers which attempt to outperform the market by identifying and buying selected securities.
Some fund managers also time the market in order to ride the upswings and avoid the downturns. In contrast, ETFs are passively managed investment vehicles that aim to track a broad market by mirroring an index. Index-based funds have the same objective as index-based ETFs but are structured and behave like actively managed funds.
Investors can utilise both ETFs and funds to lower the overall risk of an investment portfolio. A well-designed portfolio uses ETFs and funds that complement each other. For example, the main or core holdings of a portfolio, usually made up of the broad market of domestic stocks or fixed income securities, can be represented by ETFs such as FTSE Bursa Malaysia KLCI etf, MyETF-DJIM25 or ABFMY1. These ETFs trade on Bursa Malaysia and give exposure to the 30 largest listed companies in the country, the 25 biggest Syariah-compliant listed companies and a basket of government bonds respectively.
Meanwhile, actively managed unit trust funds can be used for tactical investments that require a fund manager's stock picking skills. For example, investors that believe that extra returns can be made with growth, undervalued or small-cap stocks can opt for funds with a growth or value investment mandate or a small-cap fund. These funds will complement a broad market-based ETF since both are unlikely to hold shares in the same companies.
Investors that are keen on adding foreign exposure to their portfolio, can opt for market or region specific unit trust or ETFs that invest solely in China or in developed countries. ETFs on the local stock market are currently limited to local securities, however, revisions to the guidelines in June paves the way for cross-listing of foreign ETFs on Bursa Malaysia.
Although a portfolio is diversified, it can still lose value during times of extreme market stress. In such conditions, equity markets around the world tend to behave poorly over the short-term as experienced during last year's global financial crisis. This abnormal behaviour eventually tapers out and negatively correlated markets return to moving in opposite directions. This lends credence to a long-term investing approach as investors with a long-time horizon can better tolerate short-term volatility.
Investors holding actively managed funds must monitor and evaluate performance over several years as it may take some time for a fund to perform. Consider replacing funds that consistently underperforms its benchmark and its peers in the same category. ETFs require less analysis although investors should occasionally check that its performance closely replicates the underlying benchmark.
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