Building A Healthy Portfolio

Foreword from ShareInvestor

This article “Building A Healthy Portfolio” by Serene Cheong was first published in The Business Times on 31 Dec 2007 and is reproduced in this blog in its entirety.

A good grasp of various investment approaches, their inherent risks and possible opportunities is crucial, says SERENE CHEONG

As the old saying goes: “Never put all your eggs in one basket.” And the wisdom is all the more apparent in the investment world, where diversification is the key to building an ideal and well thought-out investment portfolio.

Theoretically, a healthy portfolio should consist of negatively correlated products in order to compensate for sectoral, geographical and unique risks. And this refers to the spread of one’s wealth among investment vehicles such as bonds, insurance, bank deposits, commodities, property and equity.

Though it’s possible to build a good portfolio, the process can be painstaking as it requires investors to conduct a good deal of product research and market monitoring in order to obtain a balance of risks, opportunities and liquidity.

In the previous instalment of this two-part series featuring some possible investment approaches in the wake of the US sub-prime credit woes, we highlighted some relevant strategies for investors with a low tolerance for risk. Today, we will be exploring riskier investment products that are more suitable for those who are willing to take the gamble, in exchange for potentially higher returns. On top of that, we will be also looking at an increasingly popular trend –socially responsible investments.

Penny Stocks

A penny stock, as its name implies, generally refers to a highly speculative stock that is inexpensive (usually selling under $1). Also known as micro-cap stocks, these shares are attractive to private investors who do not wish to fork out large amounts of money for a few stocks from a firm with large market cap.

It is important to note that although such affordable stocks may potentially offer modest growth opportunities, there is also the risk of losing one’s capital in the event that these small firms delist or cease trading.

Therefore, it’s crucial to analyse the company’s background and assess the quality of its management before considering taking up its shares. On top of that, it is also important to study the stock’s previous trading records and monitor its valuation when singling out companies with sound fundamentals.

Generally speaking, speculating on penny stocks is not for the faint-hearted as these stocks are relatively more susceptible to market movements than large-cap shares.

Thus, it would be beneficial for investors to be well-informed about news and trends in the relevant industries in order to preempt possible fluctuations in the value of their assets, lest they become a case of “penny wise, pound foolish”.

Speculative Call Warrants

A call warrant gives its holder the right, but not the obligation, to buy the underlying instrument for an agreed-upon price, on or before a specific date.

Upon paying a premium, the holder of the call warrant has the right to exercise the warrant (buy the stock) at a predetermined price (called the exercise price) on or before the expiry date. The holder would do this if the current stock price is higher than the exercise price. However, in the event where the current stock price is lower than the exercise price, the holder would let the warrant expire, as it is deemed to be worthless. The loss to the holder is thus the premium paid for the warrant.

Call warrants are usually popular among optimistic speculators who see bullish market trends in the near future, but lack the funds to purchase the actual stock. Generally, a call warrant is a leveraged instrument, in that it costs only a fraction of the price of the parent stock, but can offer relatively much higher potential returns.

Emerging Markets

With the American market experiencing bearish trends in the wake of the sub-prime credit crisis, many investors are looking beyond the US in an attempt to diversify their risks and maximise profits. In fact, the global limelight has been concentrated on emerging economies for some time now, drawing investors from all over the world with its potentially high returns, albeit at a high risk.

Typically, emerging markets can be found in countries or regions that are in a transitional phase (from developing to developed status), and places like China, India and Eastern Europe fall into this category.

Many Chinese firms are listed on the Singapore Exchange and thus their stocks are easily accessible to investors here. On top of that, such stocks can also be attractive investments for young investors as they are usually very affordable.

However, as with penny stocks, a grasp of the company’s potential opportunities and threats, as well as a keen interest in foreign markets is necessary for those who wish to trade in these unfamiliar territories.

Socially Responsible Investments

In 2006, the release of Al Gore’s Oscar-winning documentary, An Inconvenient Truth, helped raise awareness about the dangers of global warming. And since then, socially responsible investments have been gaining popularity with investors who wish to align their portfolios with their values and ethics.

Increasingly, clients want their investments to have a positive impact on society, while at the same time maximise their shareholder’s value. As a result, more and more of them are actively seeking investments with companies which subscribe to the idea of corporate social responsibility (CSR).

Essentially, a firm which believes in CSR voluntarily takes responsibility for the impact of its operations on the well-being of its shareholders, communities and the physical environment.

While CSR’s harshest critics discount it as yet another tactic by companies to gain publicity and leverage on the ethical concerns of the public, socially responsible investments are blossoming in many parts of the world with products like mutual funds, exchange-traded funds and stocks.

Nonetheless, these firms will continue to benefit from its new customer base and favourable media coverage. And perhaps the biggest challenge now would be to provide stable and competitive returns, on top of maintaining their businesses in a sustainable and responsible manner.