Di­ver­si­fy­ing your port­fo­lio

Finweek English Edition - - INVEST DIY - BY SI­MON BROWN

Iwas look­ing at the re­turns of the main lo­cal in­dices since the end of the fi­nan­cial cri­sis in March 2009 (in hind­sight we can ex­actly pin­point the end, at the time we had no idea it was f in­ally all over). This got me think­ing about a num­ber of is­sues, but firstly the stats (all ex­clud­ing div­i­dends paid).

The Top40 has done around 180% as has the Mid­Cap In­dex, while the Resi10 is the lag­gard – up only 5% over the pe­riod. The Indi25 is the clear win­ner, gain­ing some 360%, with the Fini15 up around 255%.

Aside from the Resi10, they’re all de­cent re­turns but many would look at these stats and wish they’d bought the Indi25 and noth­ing else. While the Indi25 has been the clear win­ner, the real ques­tion is what would have made you buy this in­dex back in 2009. Ig­nor­ing hind­sight bias, this ques­tion per­haps poses more of a prob­lem. Let’s say you had bought the Indi25 back in March 2009, you have to at­tempt to f ig­ure out when to sell the in­dex and move i nto t he next win­ning i ndex. The re­al­ity is that there is no way the Indi25 will al­ways be t he win­ning in­dex.

The point here is that the best longterm port­fo­lio needs to be a diver­si­fied one. So in 2009 it would have in­cluded some Indi25 stocks, as well as the other mid­dling stocks and – dare I say – even some Resi10 stocks (the ar­gu­ment could be made, as I of­ten have, that Resi10 stocks are never re­ally long-term ‘ buy and hold’ stocks).

A di­verse port­fo­lio would have es­sen­tially re­turned the Top40 re­turn of around 180% for the pe­riod, around 23% a year com­pounded and well ahead of inf la­tion, thus cre­at­ing real wealth. Some t weaks (such as go­ing l ight on Resi10 stocks) would have done even bet­ter.

The beauty of the Top40 is that it is de­signed to kick out los­ing stocks whose prices are fall­ing, while adding the new win­ning stocks that are see­ing share price gains. So the Top40 from 2009 looks ver y dif­fer­ent f rom t he 2015 Top40 in­dex.

In 2009, the Top40 in­dex in­cluded 13 re­source stocks while to­day it in­cludes only si x – the re­place­ment stocks have pret t y much a l l been in­dus­tri­als. As the in­dus­tri­als start to lose their way go­ing for­ward (as will cer­tainly hap­pen, although when is un­cer­tain), they will start to drop out of the Top40 and be re­placed with the new win­ning stocks.

This self-cor­rect­ing na­ture of the Top40 in­dex is why I have it as one of the core ex­change-traded funds (ETFs) in my port­fo­lio, but I per­son­ally much pre­fer the equal weighted Top40 ETF – BBET40*.

I wil l build on t his core ETF port­fo­lio by adding the awe­some stocks that I con­sider to be the sig­nif icant win­ners over time. This is my at­tempt at out­per­form­ing the generic Top40 – t his is where we have to be ver y care­ful about which we in­clude. These in­di­vid­ual stocks have mostly been in­dus­trial stocks with a few f inan­cial and small- or mid-cap stocks – re­source stocks are not core long-term stocks due to their cycli­cal na­ture.

We could make it even sim­pler by us­ing some i ndex ETFs i nstead of i ndi­vid­ual stocks around t he core, adding prop­erty ETFs or any of the other three (Indi25, Fini15 or Mid­Cap ETFs).

With t hese i ndi­vid­ual stocks or ETFs that we add around the Top40 core, we in­crease risk, are sub­ject to be­ing wrong and can be hit by bad tim­ing, so we should do so care­fully and with at least 50% of our port­fo­lio in ETFs.

In­dus­trial stocks are likely to drop out of the Top40 and be re­placed by other win­ning stocks.

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