Saturday, August 14, 2010

Investment Strategy || Part II

Dah baca investment strategy part 1 belum?
not yet? 
sila lah singgah entry strategy investing in UT ni dulu k?
kalau rase malas nk bace, just glance tru the bold sentences k?

Protection vs Diversification
The Q is: Do portfolio protection or structured funds make good investment sense to the long-term retail investors?
Fifty-seven capital protected structured funds have been launched in the Malaysia by unit trust companies over a period of five years and ten months to May 31, 2010. They attracted total investments of RM8.5 billion from largely long term retail investors.
The key attraction of this product is that capital losses to the investor’s principal or capital arising from market volatilities can seemingly be reduced or even removed by the product’s defensive investment portfolio structure whereby a significant proportion of its investment portfolio (up to 95%) is invested in fixed income securities or bonds for capital protection. Capital gains for the product would then be secured through investing the balance of the fund’s portfolio in call options on selected market indexes that enables the product to participate up to a limited extent (called the participation rate), in gains made by the index over a specific time period.
By virtue of this conservative investment structure or strategy, it is obvious that capital gains receivable from such products would be limited or capped by the portion of the fund’s investment portfolio being invested in call options. One then begs the question, having examined the above product structure and its rationale, as to whether structured products are an alternative at all to a simple good old fashioned buy-and-hold investment strategy when investing in share markets.

Findings of a research study conducted on the performances of structured capital protected funds by academics from the prestigious London Business School, may now help to shed light on the “attractiveness” of these structured investment products.
This study, presented under Chapter 3 of the Global Investment Returns Yearbook 2007 produced for ABN AMRO by three London Business School experts – Elroy Dimson, Paul Marsh and Mike Staunton – showed that investing in risk-protected investment was, by far, inferior when compared to a simple buy-and-hold strategy of a well-diversified portfolio of assets.

Dimson, Marsh and Staunton time-tested the performances of various popular risk protection/structured strategies against the long-term historical returns (performances) of the U.S. and British stock markets spanning over a century, from 1900 to 2006.
They found strategies seeking to control risk or protect the downside risks to an investment portfolio (as is the case with structured capital protected funds) would, by the same stroke, curb the potential upside returns of the investment.

Worse, the upside potential is more likely to be eroded by more than the quantum of risk reduced. Hence, it would seem investors of structured products are far better served by adopting a more balanced portfolio strategy to protect against equity market risk.
**For a one-year investment period, diversified portfolios of equities and bonds offer far more superior long-term risk-to-reward ratios than structured/protected portfolios.

To further stress their point, Dimson, Marsh and Staunton engaged three popular portfolio protected strategies outlined below in their research to elaborate on their findings:

(i) the annual stop-loss strategy
Under the annual stop-loss strategy, the investor selects a particular stop-loss floor for his investments. Once this floor price is breached, the protection strategy immediately kicks in to convert risky assets into cash to protect its downside from further decline for the rest of the investment period. The portfolio thus exits completely from equities after a market drop had breached the stated floor, and it misses out completely on subsequent market rebounds/upsides or recoveries for the rest of the investment period. As a result, its returns would naturally be lower than that of a conventional buy-and-hold approach which stays fully invested in the broad market, and participates in future market rebounds.

(ii) the profit lock-in strategy
As its name suggests, the second strategy, known as the profit lock-in strategy, seeks to lock in profits and assure the investment of its capital gains once it reaches a certain target return by moving swiftly out of riskier assets into cash for the remainder of the investment period. This ensures that the gains made will not be lost again in case the markets subsequently weaken. Research findings by Dimson, Marsh and Staunton highlighted that over the long-term, lock-in portfolio investment strategies lowered the funds’ annualised equity returns to a level that was only slightly above that for U.S. bonds and Treasuries. These returns were, of course, significantly lower than that of annualised U.S. equity returns which investors of a diversified portfolio would receive in the long-term.

(iii) the “costless” collar strategy
In the third strategy, Dimson, Marsh and Staunton attempted to hedge against market declines through a costless collar that revolves around the fund selling a call option to generate some income, and using part of this income to buy a put option to protect the portfolio on the downside (hence the term “costless” protection).

However, this would result in a tight collar band between portfolio protection and returns –
the higher the level of protection required, the lower would be the expected investment returns and vice versa – since the investor/fund can only participate in a market run-up to a maximum of the call strike price.
U.S. research findings showed that a portfolio based on this strategy which is rebalanced monthly to limit its downside loss to 1 percent a month, resulted in a long-term annualised return of only 1.12 percent when compared to 9.77 percent from a simple buy-and-hold strategy. Once this protection floor is lowered to -10 percent (marking a huge, significant increase in portfolio risk), the returns to the portfolio improved to 9.3 percent.
Dimson, Marsh and Staunton hence concluded thus that structured/protected strategies are sub-optimal since one would be able to achieve the same given return or better, by simply allocating his assets between equities and cash. In a similar vein, one would also be able to reap higher returns using the same approach for a given level of risk. Over the period 1900 – 2006, U.S. equities were able to achieve an annualised return of 9.8 percent (at volatility of 19.8 percent) versus protected portfolios’ annualised return of 6.9 percent (at volatility of 18.6 percent).

It can, thus, be concluded that while protected strategies may reduce risk, they are done so only at a “relatively high” price to returns. The long-term investor would truly be much better-off in terms of both risk and return had he just stayed with portfolio diversification of his assets, rebalancing it whenever necessary. In truth, structured products are hardly considered an efficient method to control portfolio risk. Research has again proven that in the case of long-term investors, portfolio diversification and not portfolio protection paves the way to higher returns at minimal risk.

And unlike short-term investors, long-term investors are not penalised by short-term market downturns because of their long-term investment horizon. For them, portfolio diversification represents a far better and less costly option than seeking portfolio insurance through investing in a structured product or fund. This is more so in light of the experts’ key findings confirming the under-performance of protected portfolio strategies against the conventional buy-and-hold investment approach.


Source: UTC Connect.

So?
As conclusion?
it is less hassle if you make your investment for a long term ;)

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