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Achieve your life goals through portfolio construction

3 September, 2020

Whether you’re getting married in three to five years’ time, or preparing for a comfortable retirement 30 to 40 years later, it makes sense to grow your savings through a sound financial plan over time. This way, you are better-placed to achieve the desired amount in the target timeframe.

While it may be tempting to dabble in equities, or trade in forex with hopes to make an easy return, they are neither effective nor systematic ways to manage your money. This is especially true when investing over a long period or during periods of economic uncertainty.

In order to steadily achieve your goals, you need to construct a portfolio that takes into account asset allocation, risk management and capital appreciation.

Generally speaking, portfolios can be classified into three types – growth, balanced and conservative. The difference between the three lies mainly in the proportion of risk assets (e.g. equities) in the portfolio.

Equities are potentially more volatile. Generally, the higher the proportion of equities in the portfolio, the higher the potential gains (or losses). For the sake of simplicity, we shall focus our discussion on equities and bonds.

What are the key types of portfolios?

Growth portfolio: The key objective of this portfolio is to achieve long-term capital appreciation. To maximise potential returns, assets are allocated mainly into equities, usually of a proportion between 60% and 100%. It is suitable for investors who are more aggressive and have a higher risk tolerance.

Balanced portfolio: With a goal of achieving balanced long-term capital appreciation, asset allocation is not concentrated on just equities or a single asset class. Instead, instruments with lower volatility (such as investment grade bond funds with regular income distribution features, exchange-traded funds (ETFs), money market funds and cash) are used to balance the overall volatility of the portfolio. It is therefore suitable for investors who can tolerate a medium level of risk, and are aiming to strike a balance between risks and returns.

Conservative portfolio: The objective of this portfolio is to seek steady growth and control downside risks. With stability as a key focus, this portfolio type holds a smaller proportion of equities, typically not exceeding 20% to 30%, so as to minimise volatility. Conservative portfolios are suitable for investors who are more conservative and cannot tolerate large investment losses.

Asset ratios in the three aforementioned portfolios are for reference only. These classifications are not standardised; the risk profile of a portfolio depends largely on the largest asset class in the portfolio.

How have these portfolios performed in the past?

An investor’s investment horizon is different at various life stages, ranging from anything between 3-5 years and 30-40 years. It can also span multiple economic cycles. Historical data shows that during economic downturns, portfolios with a higher proportion of bonds can buffer downside. In other words, it helps investors to better manage downside risks.  

However, when the economy recovers, equities tend to outperform bonds due to better corporate earnings, improved corporate and consumer confidence, as well as higher risk appetite in investment markets. As a result, equity markets attract more capital inflows. In this part of the market cycle, the overall return is higher for portfolios with a greater proportion of equities.

As shown in the table below, the MSCI World Total Return (USD) Index and Bloomberg Barclays Global Aggregate Bond Index (USD hedged) show that the value of growth portfolios rose more than 160% in the last economic upcycle; balanced portfolios holding equal proportions of equities and bonds rose slightly less (approximately 120%) while conservative portfolios with only 20% of equity holdings gained 83%.

Yet when the economy is not doing well, equities often perform worse than bonds and this in turn drags down the portfolio’s overall performance. Figure 1 shows that growth portfolios lost nearly 30% in the last economic downturn; balanced portfolios, with 30% more bond holdings than growth portfolios, fell less (approximately 16%) while conservative portfolios with almost 80% holdings in bonds fell around 2%.

Portfolio returns under different periods and economic cycles1

What are the different instruments available for investors?

In order to effectively manage risks and achieve capital appreciation, investors should consider the different instruments available.

To gain exposure into equities, investors can look into single stock or various equity funds. For example, investors can consider global or regional equity funds, sector-specific equity funds, or even ETFs which track equity asset performance.

It is worth noting that while these instruments belong to the same asset class, their risk levels vary. For example, a single stock or single-country equity fund is generally riskier than a global equity fund.

Similarly, there are also many types of bond instruments. They include government bonds, investment-grade bonds, high-yield bonds, preferred securities2 as well as bonds denominated in different currencies, or from different markets, regions and sectors.

Apart from equities and bonds, investors may add on other assets such as foreign currencies, real estates, and commodities in their portfolios according to their actual needs, so as to further balance between risk and return.

How should investors start constructing their investment portfolios?

There are two ways to construct a portfolio:

  1. Multi-asset funds: These funds make flexible allocations across different asset classes, adjusting for factors such as investment objectives and market risks. These portfolios are usually made up of dozens of holdings, offering growth, balanced and conservative options, or different options for various retirement objectives, with a range of equity-to-bond ratios for investors to choose from.

    Another type of multi-asset fund is “fund-of-funds”, usually targeted at retail funds. By investing in a basket of funds, it may contain up to hundreds of holdings, which further helps to diversify risks.

  2. Self-constructed portfolio: Investors may also choose to construct their own portfolios by buying different asset classes directly through personal investment accounts. The investor handles the entire process, from screening and trading to asset allocation.

Comparing the two options, the first option is managed by professionals. Therefore, it saves investors the hassle of figuring out the right combination of holdings. It also holds a scale advantage and offers access to investment tools used by global retail and institutional investors. This option is easier than managing a portfolio on your own.

If you have any questions about portfolio construction, or any specific financial requirements, please speak with your financial advisor. 

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1  Source: Bloomberg, as of 30 June, 2020. Total returns in USD. Equities are represented by MSCI World Total Return (USD) Index; while bonds are represented by Bloomberg Barclays Global Aggregate Bond Index (USD hedged), assuming monthly rebalancing for each portfolio. The periods of economic cycles were based on the US economic cycle stated by the US National Bureau of Economic Research. Past performance is not indicative of future performance. The information above is for reference only. Investors cannot invest directly in an index.

2 Preferred securities are fixed-income instruments with equity-like features.

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    read more
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    read more
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