Wednesday, January 27, 2010

Strategies of a financial adviser

Wed, Jan 27, 2010
The Straits Times

By Chris Firth

What do financial advisers do with their own money that most individuals don't do? I can't speak for advisers as a group, but I can give you a selection of insights into my own strategies. But bear in mind that these approaches may not be suitable for everyone.

I don't use fixed deposits
Almost everyone has a need for a safe place for cash. However, fixed deposits are not on my shopping list. I would use a money market fund instead. A unit trust that calls itself a 'money market fund' must comply with strict guidelines on quality, issuer and tenure. The result is a low-risk investment that easily outperforms a fixed deposit if you can live without a guaranteed return. Currently, a 12-month fixed deposit promises you a paltry 0.45 per cent or so. In contrast, the LionGlobal SGD Money Market Fund is averaging around 1.3 per cent and the Phillip Money Market Fund around 1 per cent.

I invest when most investors are pessimistic
At least, I try to. If you can keep your nerve, crises are good times to buy equities. During the second half of 2008, I built up a six-figure investment in the Legg Mason Southeast Asia Special Situations Fund. That decision didn't look too smart in March last year but is now booking a healthy profit. Why this particular fund? It has a high beta (moves rapidly compared to the broad market) and the fund manager seems to benefit more than most from rising markets. Importantly, though, I keep my overall exposure to equities comfortably inside my personal risk threshold. So even if things go wrong, it won't be a disaster.

I don't buy stocks but do buy options
Unlike many of my clients, and possibly fellow advisers, I rarely buy individual stocks. The reasons are twofold. First, once you start looking at an individual firm, you have to do your homework extremely well. This can be very time-consuming, if done properly. Unlike the risk of an index or well-diversified fund, company risk comes in a myriad of flavours.

Second, when I do have a strong view on a firm, I am more likely to buy options than shares. Options give you the ability to take many different positions: optimistic, pessimistic or looking towards a certain pattern of future price movements. Options also allow significant profits to be made through their inherent leveraging.
It's not extraordinary to have returns of 100 per cent to 500 per cent (or a loss of 100 per cent). My rationale is: If you have a strong conviction on a counter and have put in the effort to research it, then don't bother with the stock - go for an option. I would buy options on United States stocks. If you want broad market exposure, buy exchange traded funds or unit trusts.

I see fear as a way to hedge
VIX is short for the Chicago Board Options Exchange Volatility Index, a measure of implied volatility. It is sometimes called the 'fear index', and is generally high when there is negative sentiment in stock markets. During the recent crisis, the VIX hit 80, compared with its more usual range of 10 to 30.

It is possible to buy this index by using VIX call options, effectively betting on rising fear. These call options will rise in value as the VIX rises. This is a strategy I have successfully deployed in the past three to five years. Sadly, I did not have the imagination in 2008 to see the VIX surpassing 80 (thinking that a level of more than 40 was already too pricey). However, one missed opportunity doesn't invalidate the approach.

I think the Central Provident Fund (CPF) Special Account savings can't be beaten
Over the short or medium term, the current rate of 4 per cent on the CPF Special Account (SA) is an extremely good deal on a risk-reward basis. The only rational justification for eschewing the 4 per cent and investing under the CPF Investment Scheme is to have a very long horizon and choose a fund with as much equity exposure as is allowed. An important point here is that returns must be viewed in the context of their risk. A 4 per cent return in Singapore dollars with no risk is great.

I think whole life insurance is a good diversifying investment
It's been fashionable in the advisory industry to knock whole life insurance. But the smoothing ability and long-term investment horizon of insurance companies shouldn't be sniffed at. A whole life plan is a good instrument to diversify your portfolio and can insure you for life to boot. However, if I were looking for only protection, I would certainly include term plans in the insurance mix.

I won't take a car loan
Anyone intending to buy a car should try to avoid or minimise a car loan, as they are much more expensive than they may appear. A typical car loan at 2.45 per cent represents an effective borrowing rate of almost double, around 4.65 per cent. Why? All the car loans I have seen charge interest each year on the full amount borrowed, rather than on the balance outstanding. If you avoid borrowing at 4.65 per cent, that is equivalent to investing in a product that guarantees you a 4.65 per cent return. Such a product would be a smash hit if launched today. Hence, not taking a car loan beats even the CPF SA savings rate.

I believe short-term returns are mainly random
No one I have heard of forecasts markets accurately and consistently, nor has anyone been able to create a reliable model of economies. Moreover, the past is a poor guide to the financial future. Investment guru Warren Buffett reportedly said: 'If past history was all there was to the game, the richest people would be librarians.' It's best to take the view that over the short run (for example, the 12 months of this year), there is a huge random element affecting the outcome of the economy and stock markets. The art of investment starts with the calm acceptance that you don't know what is coming next.

The writer is the chief executive of wealth management firm

This article was first published in The Straits Times.

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