Managing wealth

YAP MING HUI: Managing wealth like a business
By YAP MING HUI

2008/09/20

MANAGING and maximising wealth is a vastly different kettle of fish from creating wealth. However, all entrepreneurs and business owners who have successfully mastered the art of creating wealth will need to know how to maximise their created wealth, or risk losing it. Managing created wealth becomes even more challenging when it grows tremendously, usually due to the sale or listing of a business.

When business owners sell their enterprises or take their companies public, they will have a huge amount of cash to manage.

Indeed, the task of managing such wealth is similar to managing a company. In other words, you might have sold one business, but as a direct result, you have now gone into the business of managing your wealth, with the goal of maximising it.

Being in the "wealth maximisation business" involves more than simply hiring investment fund managers to invest in listed shares, bonds, real estate, commodities or hedge funds.

In addition to investment, this business involves other critical components like developing a family philosophy concerning the goals for the wealth, establishing an investment policy, selecting good professional advisers and getting family members interested in and educated about the process.

As with any other business, you need proper planning and effective execution for your wealth maximisation.

Where should you start? It makes sense to go over some general issues. Since your family will be directly affected by any decision you make, make sure you get input from your family through family meetings when asking questions like those below:

- What are the goals for your wealth maximisation? Figure out your priorities and take all the financial, mental, physical, family, social and spiritual dimensions into account when formulating your goals. Clearly defining your core values for the family and goals for the shared wealth are critical elements for sustaining the family legacy. Where do you envision your family a generation from now? What are your goals for the wealth?

- Do you want to preserve the "purchasing power" of your assets, striving for returns that outstrip inflation and taxes? What level of risk are you willing to face to gain these higher returns?

- Which ownership structure is appropriate for you? Structuring assets properly has a greater long-term impact on your wealth. At times, its impact is greater than some of your investment decisions. How will the decisions you make about asset ownership structure today affect your children's grandchildren?

- How do you diversify your wealth so that not all your eggs are put in the same basket? What dimensions and levels of diversification should you consider? What alternatives are available out there for you to effectively and efficiently diversify and preserve your wealth? Is your current wealth allocation well diversified?

- Every family faces its own unique set of risks that may deplete or even wipe out its hard-earned wealth. Discussing, identifying, documenting and developing measures to address the risk factors prepare the family with the necessary competencies to weather distressing events.

- How active can you and other family members be in the wealth maximisation process? Documenting the family's mission and a process for decision-making are critical first steps in developing a wealth maximisation framework. How involved will family members be in the wealth maximisation process? Who will make important decisions and how will these important decisions be communicated to the rest of the family?

- How will you ensure the financial education of younger family members? Great wealth carries great responsibility. Family members who are taught that they are stewards or protectors of the family wealth are usually far-sighted in making decisions that are best for the family in the long-term.

- What positive changes do you want to affect in society? Is it important for your family to create a foundation or to develop a philanthropic programme to support your social aspirations? How do you involve your family members and align your family values with your charitable goals?

- What are the benchmarks of successful wealth maximisation? It is important to periodically assess actual performance relative to wealth maximisation goals and the family mission. How does your family incorporate the latest changes in the family and environment to achieve mid-term and long-term goals? How often and how should an assessment be conducted?

- Where can you find professional advisers with the expertise and integrity to work on your behalf and to represent your interests? The most critical issue is to find intelligent, strategic thinkers whose judgment you can trust in advising you about financial decisions. They can facilitate the setting of objectives, the formulation of a strategy and plan, and the correct choice of structures and people to implement and monitor the plan effectively.

How do you identify, engage and motivate the professionals you need to pursue the family's agenda?

According to Sara Hamilton from the Family Office Exchange (FOX), managing wealth successfully, like managing a business, requires thoughtful planning, diligent research and the construction of a fully-integrated plan to coordinate all the components of the process. The steps include documenting a family mission statement, articulating investment goals, and providing beneficiaries of the wealth with the financial information needed to make good decisions. Managing wealth properly is as complicated as managing a business properly.

The ultimate challenge is to synchronise the goals of family members with the necessary strategies and structures required to maximise wealth.

To achieve this, you will need to coordinate a team of experienced professionals to ensure that decisions are made with the goals of the family in mind.

To succeed in your new business of wealth maximisation, it is important that you take enough time to think through the important issues listed above, learn from the experiences of other families who have gone through the experience with success and get your family members to be involved in the process.

Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia


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© Copyright 2009 The New Straits Times Press (M) Berhad. All rights reserved.

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2354018/Article/pppull_index_html

Set clear investment policy statement

NST Online » Focus
2008/09/07

Business: Set clear investment policy statement
By : Yap Ming Hui


The great Greek philosopher and mathematician Plato said: “The beginning is the most important part of the work.”

After you have developed a financial plan, you are ready to start investing for your financial goals — almost, but not quite. It is time to have an investment policy statement where you set parameters within which the portfolio is to be managed over time.

Why have an investment policy statement

The principal reason for an investment policy statement is to protect your investment portfolio from ad-hoc revisions of sound long-term policy.

The investment policy statement is used to keep our selves from taking those unwise actions that seem so “obvious” and urgent to optimists at market highs and to pessimists at market lows.

As human beings, we like best those upward market movements that are most adverse to our long-term interests, and most dislike those downward market movements that are, in fact, in our long-term interests

As such, investors need protection from their human proclivities toward unrealistic hopes and unnecessary fears. Therefore, the best shield against the outrageous attacks of acute short-term data and distress are knowledge and understanding — committed in writing.

We can think of an investment policy statement as a letter of understanding between the investor and the investment manager.

In the absence of professional investment manager, it is a letter of understanding between you and your own self to protect the investment portfolio. The problem, as Santayana so aptly put it, is that “those who cannot remember the past are condemned to repeat it.”

The benefits of investment policy statement

The benefits of a proper investment policy statement are as follows:

- It provides a written description of the investment decision-making process from objective setting through implementation and ongoing monitoring of progress toward the goal

- Is a model against which to measure performance

- Provides a framework for evaluating new investment opportunities as they come along

- In the case of using a professional investment manager, an investment policy statement can provide for continuity in investment approach as new investment manager replaces those who are stepping down

- Serves as the non-emotional tether that you can use to ground yourself when markets are misbehaving and the temptation to act impulsively or irrationally is high. This is particularly important during extremely good or bad stock market environments

- Can be made part of the financial or estate plan. This could be particularly important for older investors who have build sizeable portfolios. When the investor dies, the estate executors or administrator won’t have to second-guess the intended investment strategy of the portfolio. It can be left intact for the heirs for many years if that was the deceased’s wish. This might be desirable when the heirs are minors or have spendthrift habits.

Content of an investment policy statement

A complete investment policy statement must be able to establish useful guidelines for investing that are appropriate to the realities of your objectives and the realities of the investments and markets. As such, there are two main components of an investment policy statement. First is your objectives and tolerance of risk. Second is the external realm of investment market.

In short, investment policy statement is the linkage between your long-term investment objectives and the daily/ weekly investing home works.

A proper and complete investment policy statement is set out as follows:

• Background and purpose.

- Why the investment policy statement was written — by whom, for whom and when.

- Who has the responsibility for what

• Objectives

- Projected financial needs — how much and when

- Present asset allocation — where are you today?

- Risk tolerance and time horizon of the investor

- Risk profile and investment time of the portfolio

• Investment policy

- The “rules” by which the investment strategy will be implemented

- Acknowledgement of the uncertainties of investing

- Investor preferences for asset classes or securities

- Desired rate of return

- When and how to re-balance

• Security selection

- Criteria for choosing securities

- List of types of securities not to be included in portfolio (eg, tobacco, alcohol, gambling)

- List of types of transactions not permitted (eg, leverage, options, commodities)

• Duties and responsibilities (if engaging professionals)

- The investment manager

- The custodian

• Manager selection (if engaging a professional investment manager)

- Results — cumulative and year-by-year

- Risk — volatility

- Rank — peer group performance

- Resources — Who is running the show? Services?

• Control procedures — monitoring

- Monthly — current holdings, market value and transactions

- Quarterly — How is the portfolio doing against the benchmark? How is the manager doing against his or her peers? Is the asset allocation being followed?

- Annually — Review investor’s risk tolerance, desired rate of return, asset class performance and time horizon to major financial needs. Analyse expenses and fees paid.

• Appendix

- Modeled return, standard deviation and correlation statistics for the asset classes used to diversify the portfolio

The test of a good investment policy statement

A well-written investment policy statement should be able to let anyone reviewing the investment portfolio to follow what was done. Guidelines should be specific enough to make it clear what was intended, yet give whoever is charged with implementing the strategy authority to actively (but prudently) manage the portfolio.

The litmus test for a well-written investment policy statement is whether there is sufficient detail and clarity for the investment portfolio to be implement by an investment manager who is unfamiliar with you (whether professional is engaged or not).


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Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia

http://www.nst.com.my/Current_News/NST/Sunday/Focus/20080907092919/Article/index_html?query_start=26&query=''

Dollar Slams Up Against a (Great) Wall

Dollar Slams Up Against a (Great) Wall
by Robert Lenzner
Friday, March 27, 2009
provided by

The People's Bank of China flexes its muscle in call for a new reserve currency.

Move over Ben Bernanke. Step aside Tim Geithner. There's a new power in international finance: Zhou Xiaochuan, governor of the People's Bank of China, the $2 trillion central bank of China. It has the tools and the financial interests to be the new power player on the global financial stage.

Zhou Xiaochuan--better learn how to spell it and pronounce it--threw down the gauntlet this week at the Obama-Geithner-Bernanke financial regime. His remarks can only be interpreted as a slap in the face of U.S. policy during the severe financial crisis that has swept the world. His prescriptions are bound to be debated in London next week at the G-20 parley and for years to come.

Boldly stated, Zhou--backed by Russia, Brazil and India--wants to break the dollar's hegemony in global finance. In a paper grandly called "Reform the International Monetary System," Zhou has called for the creation of an international currency unit that he admits will require "extraordinary political vision and courage." He suggests that we start with a blend of the dollar, pound, yen and euro--the so-called Special Drawing Rights (SDR) created by the IMF in 1969 that borrowed a concept first recommended by famed economist John Maynard Keynes.

Zhou's provocative remarks come only days after Premier Wen Jiabao demanded U.S. action to safeguard China's holdings of U.S. bonds--some $740 billion of Treasuries and $600 billion of other debt.

"We have lent huge amounts of money to the U.S. [and] we are concerned about the safety of our assets," said Wen. Indeed, China has bought $200 billion of Treasuries while selling agency securities over the past six months. But it also lost about a third of its equity holdings, including $5 billion in the Lehman bankruptcy.

Zhou's rationale appears reasonable to Croesus. "A super-sovereign reserve currency not only eliminates the inherent risks of credit-based sovereign currency, but also makes it possible to manage global liquidity," writes Zhou. "This will significantly reduce the risks of a future crisis and enhance crisis management capability."

By the way, don't dismiss Zhou as just a voice in the wilderness. His plan for a global reserve currency is backed by multibillionaire trader and economic wiseman George Soros, as well as Martin Wolf, an influential columnist for the Financial Times. Geithner, queried at the Council on Foreign Relations on Wednesday, said he hadn't read Zhou's proposal, but praised his counterpart as "a very thoughtful, very careful, distinguished central banker." Geithner added that he was "quite open" to the suggestion of expanding the SDR's role.

Zhou has surprised the experts by suggesting that international financial institutions such as the International Monetary Fund should manage some nations' currency reserves. The IMF uses its funds to prop up nations in financial crisis. Expanding the SDR would give the IMF the potential to "act as a super-sovereign reserve currency" and to increase the IMF's resources, Zhou emphasized. "The scope of using the SDR should be broadened so as to enable it to fully satisfy the member countries' demand for a reserve currency," adds Zhou.

This would be a shocking change in a system where central banks maintain control over their reserves and many keep their operations entirely secret and non-transparent. Zhou makes a telling point when he insists that "the centralized management of part of the global reserve by a trustworthy international institution will be more effective in deterring speculation and stabilizing financial markets." In other words, Zhou is saying that the recent vicious meltdown might have been avoided if the world's financial system was not tied solely to the American dollar, the currency at the focal point of the global economy.

"For a country like China that prizes its sovereignty and to date hasn't even been willing to report the currency composition of its reserves to the IMF [something most other countries do], this would be a big step," says Brad Setser, a fellow of the Council on Foreign Relations and former Treasury official in the Clinton administration.

In a second address Thursday, Zhou took an even tougher whack at some American institutions and financial concepts. He blasted the way "the global financial system relies heavily on the external credit ratings for investment decisions and risk management." Having three U.S. ratings agencies dominate the world results in "a massive herd behavior at the institutional level. Moreover, the rating models for mortgage-related structured products are fundamentally flawed." All true. The massive write-downs across the globe were the result of these flaws in the American way of doing things.

Then, Zhou goes on to blame the American fair-value accounting system and especially the mark-to-market model for the intense market fluctuations and disorderly trading. Take that America. China described the "negative feedback loop" as the most toxic American export ever. Zhou also crowed about how China's "macroeconomic measures," including a massive stimulus program, have produced "some leading indicators pointing to recovery of economic growth, indicating that rapid decline in growth had been curbed."

Then, Zhou really stuck it to Obama-Geithner-Bernanke, as well as to Europe and Japan. "Facts speak volumes and demonstrate that compared with other major economies, the Chinese government has taken prompt, decisive and effective policy measures, demonstrating its superior system advantage when it comes to making vital policy decisions." Talk about gauntlet dropping.

Copyrighted, Forbes.com. All rights reserved.

http://finance.yahoo.com/banking-budgeting/article/106817/Dollar-Slams-Up-Against-a-Great-Wall;_ylt=AoJCjKtUf1TYF.q1mz7X1yBO7sMF

G20 summit: blow for Gordon Brown as £1.4 trillion spending blueprint is leaked

G20 summit: blow for Gordon Brown as £1.4 trillion spending blueprint is leaked
Gordon Brown's preparations for this week's G20 summit in London got off to a bad start last night when a British blueprint for a £1.4 trillion worldwide spending boost was leaked.

By Patrick Hennessy, Political Editor
Last Updated: 11:20PM GMT 28 Mar 2009


In an embarrassing disclosure, a draft of the final communiqué to be signed off by world leaders at the end of the one-day gathering on Thursday appeared in the German magazine Der Spiegel.

There were suspicions that the leak was a deliberate act of sabotage by sources within the German government, where Chancellor Angela Merkel is adopting a more cautious approach to fiscal moves to boost the national economy than Mr Brown, who will chair the summit.

A Downing Street spokesman said the leak was an "old document with out of date figures" and that the £1.4 trillion was an estimate by the International Monetary Fund (IMF) of stimulus measures already introduced by G20 countries. No new money was included, the spokesman added.

The comments, though, only served to increase speculation that Mr Brown was being forced to scale down ambitious plans because of international opposition, led by Germany and France.

Ahead of the summit, which will be held at the ExCel centre in London's Docklands, Mr Brown unveiled plans for a new crackdown on tax havens across the world.

Lord Owen, the former Labour foreign secretary, also warned that unless inflation was controlled, Britain's economy might have to be constrained by the IMF.

David Cameron's Conservative Party also widened its lead over Labour to 13 per cent in an ICM opinion poll for The Sunday Telegraph.

The leaked communiqué mentioned a figure of $2 trillion – £1.4 billion – in brackets, signifying it was a proposal for spending by G20 nations by Britain, as summit host, that still had to be formally agreed. According to the leak, this would boost growth by two per cent and employment by 19 million.

The draft also suggested that Britain wanted the G20 to come up with a target for global growth in 2010 – although no figure was mentioned.

The document stated: "We are determined to restore growth, resist protectionism and to reform our markets and institutions for the future.

"We believe that an open world economy, based on the principles of the market, effective regulation and strong global institutions, can ensure sustainable globalisation with rising wellbeing for all."

Insiders at Der Spiegel said the magazine had obtained the leak from German government sources.

British officials, however, declined to blame Mrs Merkel's inner circle directly, pointing the finger of blame instead at smaller political parties inside her ruling coalition.

A No 10 spokesman said the £1.4 trillion figure did not amount to "extra money" which Britain was calling for governments to spend to try to rescue economies which have been crippled by the credit crunch, but referred instead to estimates of expenditure which had already been made.

Mr Brown has faced claims that he wants to use the Budget, on 22 April, to unveil a big new fiscal stimulus for Britain while Alistair Darling, the Chancellor, and Mervyn King, the Bank of England Governor, are advocating caution.

The Prime Minister wants a main focus of the summit to be a clampdown on tax havens, with a three-point plan aimed at building on moves which have already seen Switzerland and Liechtenstein agree to abide by new transparency standards.

Britain will push for support on new moves to use tax incentives to stop companies and individuals trading with those who are resident in "non-compliant jurisdictions", Government sources said, while there will also be new measures requiring companies to disclose more details of dealings with tax havens.

The third part of the proposed clampdown involves a review of investment policies of institutions such as the IMF and retail development banks with a view to cutting the funds available to tax havens.

Amid the frantic preparations for the summit Lord Owen, foreign secretary under Jim Callaghan in the late 1970s, uses an article in today's Sunday Telegraph to warn that Britain's economy might have to be subject to "IMF disciplines" – which would require painful public spending cuts – to halt a "precipitate loss of confidence".

Lord Owen sounded the alert about the twin threats of a falling pound and inflation, which crippled Callaghan's government, being repeated under Mr Brown. "There is an air of breathtaking unreality in Westminster and Whitehall that reminds me of 1975," he wrote. "Hard choices need to be taken now, not postponed until after an election in 2010."

His comments are certain to infuriate ministers, Labour MPs and activists, many of whom still blame him for his role in splitting Labour by forming the Social Democratic Party (SDP) in the early 1980s.

In autumn 2007, two months after Mr Brown became Prime Minister, the two men held talks in Downing Street, leading to speculation that the peer was considering returning to the Labour fold.

Lord Owen's warning about the IMF echoed similar alerts sounded recently both by George Soros, the Hungarian financier, and Mr Cameron.

Meanwhile, George Osborne, the shadow chancellor, used a speech yesterday to Welsh Conservatives in Cardiff to taunt Mr Brown over his stewardship of the British economy.

Mr Osborne said: "When Gordon Brown sits down with the other G20 leaders in London next week, he will have to explain why he, of all the people sitting around the table, has the highest budget deficit – why the economy he presides over, of all the economies represented at the table, is forecast to still be in recession next year."

http://www.telegraph.co.uk/finance/financetopics/g20-summit/5067296/G20-summit-blow-for-Gordon-Brown-as-1.4-trillion-spending-blueprint-is-leaked.html

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It's time to admit inflation is going to be a major problem

It's time to admit inflation is going to be a major problem
I don't wish to be smug. But can we now agree that, despite repeated warnings from ministers and the City, the UK won't get caught in a "deflationary spiral" and inflation is a much greater danger?

By Liam Halligan
Last Updated: 5:11AM BST 29 Mar 2009

Comments 0 Comment on this article

For months, this column has argued that the spectre of deflation has been conjured up by those whose hubris and incompetence caused this crisis.

It's given Gordon Brown an excuse to indulge the Keynesian wet-dreams of his political adolescence, spending our money willy-nilly, with absolutely no regard for the impact on future generations.

Our economy is being held to ransom by deflation fear

Even before this sub-prime debacle, his borrowing was far too high.

But having failed to put the UK's fiscal house in order during the good years, Brown has now set fire to the whole shebang.

The reason, we're told, is that because deflation is imminent, "the danger of doing too little is greater than the danger of doing too much".

"Deflation is coming" has been the mantra of the City economists too.

Could their views be influenced by the institutions employing them?

Hyped-up deflationary fears have certainly led to an awful lot of taxpayer-funded "soft credits" being chucked towards the Square Mile.

Meanwhile, the supposed cure, "quantitative easing" (sic), is allowing banks that should fail, that need to fail, to rebuild balance sheets they themselves destroyed by years of wild risk-taking. So, if you're a washed-up, spendthrift Prime Minister, or a banking executive desperate to cover up past mistakes, "look out, deflation" is a useful message to get into the mind of the public.

Barely pausing to look at the evidence or question WHY our so-called leaders are saying this, the press has too easily obliged.

The UK economy contracted 1.6pc during the final three months of 2008 and 0.7pc the quarter before.

This is now a deep downturn – the worst since the early 1980s and counting. Retail sales growth was a perky 3.8pc in January, but slumped to 0.4pc last month.

Despite that slowdown, and the "deflation is nigh" warnings, CPI inflation ROSE in February – to 3.2pc, up from 3pc the month before.

So grave is the deflationary danger that the Bank of England has just written a letter to the Treasury explaining why inflation remains ABOVE its 2pc target – as it has been for 17 months.

RPI inflation fell marginally last month, to 0.0pc. But that measure stresses house prices – which, of course, have dropped sharply.

Desperate to drum up more free taxpayers' cash, City economists were only last week forecasting the February RPI number would be minus 0.7pc. How wrong can you be?

The RPIX – similar to RPI, but excluding housing costs – also rose last month and, while the deflationists tried to attribute February's CPI number to rising food prices, "core inflation" – which excludes items with volatile prices such as food – shot up too.

Why? Because, weighed down by lax fiscal and monetary policy, the pound has lost a third of its value in just over a year.

That pushes up import prices and overseas goods account for a very high share of UK household spending.

In my view, inflation will get much worse in the medium term.

By the time "quantitative easing" is over, the UK will have more than doubled its monetary base.

Deflationists say low lending offsets that but M4 – the broadest monetary measure, which includes bank lending – is still growing by 16pc a year.

Lending to households is 5pc down on last year. Lending to firms is still expanding but only by 4pc, compared with 15pc average annual corporate credit growth since 2005.

But credit to OFIs – other financial institutions – is now growing at a colossal 45pc annual rate, so banks are "still lending", as they say, but mostly to their own off-balance sheet vehicles
which they set up in previous years to take crazy risks.

That lending will find its way into the economy and is still inflationary – even if ordinary punters are "credit crunched".

So, both base and broad money are now expanding rapidly – storing up huge future inflation, despite the slowdown.

I accept that, during the early summer, the RPI may go negative for a month or two. Oil prices were up above $140 in May and June last year, and will this year be much lower – weighing heavily on the index. But such "base effects" will be short-lived and very quickly reversed.

Oil was $40 a barrel in December 2008 and, as explained below, could easily be at $60 by the end of this year – 50pc higher.

That will send the inflation indices into orbit, just as the vast monetary expansion starts feeding through.

So, please, let's stop pretending deflation is a problem.

We need an honest, robust debate about fiscal meltdown, bank balance sheets and future inflation – the genuine problems we face.

West set for a crude awakening

AS THE G20 denizens battle to save the global economy, one positive they can point to is the price of oil. Since soaring last summer, the cost of crude has collapsed.

That lowers fuel bills and helps Western oil importers cut their (often gaping) trade deficits. How bad would things be if, as well as financial meltdown, we had high oil prices too?

Well, that could easily happen. Oil prices moved firmly above $50 last week – almost 40pc up from their February low. Until now, most economists have accepted the "demand destruction" story – assuming a slowing world economy would use less oil, keeping a lid on prices.

But crude has recently rocketed, despite the prospects for global growth being worse than at any time during this crisis. Across the Western world, GDP growth forecasts are being scythed. The US, the world's biggest oil importer, is now contracting at its fastest rate for three decades. In Japan, the world's second largest economy, oil imports are at a 20-year low.

So why is oil going up? Well, "demand destruction" was never as big a deal as economists in oil-importing countries wanted to believe.

The big emerging markets now account for a large share of world-wide oil use. Their population growth, and on-going economic expansion, is keeping global oil demand firm.

At the same time, recent low crude prices have caused production cutbacks. In the past six months, the number of active oil rigs in the US – still a major crude producer – has dropped nearly 50pc.

Even worse, high credit costs have led to much lower spending on future production capacity.

In Saudi, UAE, Russia and other leading producers, numerous oil infrastructure projects have lately been mothballed or axed.

That's one reason why oil markets are showing such a steep "contango" – with futures contracts way above today's "spot" price. Oil for delivery in December 2009 is now more than $60 a barrel, rising beyond $70 a year later.

Something else is going on too. Across the world, many sophisticated investors and money-managers have never believed the self-serving "deflation is coming" mantra being pumped-out of London and Washington. And as Western governments lose control and central bank printing presses crank-up, the "inflation not deflation" crowd is growing.

That's why oil prices are rising. As a tangible, scarce asset like gold, crude is increasingly being used as an easily tradable anti-inflation hedge.

http://www.telegraph.co.uk/finance/comment/liamhalligan/5066497/Its-time-to-admit-inflation-is-going-to-be-a-major-problem.html

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Deflation: How to protect your portfolio

Deflation: How to protect your portfolio
Should you be protecting your portfolio against deflation or inflation, or hedging your bets? Emma Simon looks at the options

By Emma SimonLast Updated: 9:37PM GMT 27 Mar 2009

Investors face some tough choices as "zeroflation" leaves them caught between the Scylla and Charybdis of deflation in the short term followed by the risk of inflation in the medium to long term.

Should they be turning to the safe haven of government gilts as a hedge against deflation and economic depression?

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Or is there a bigger threat on the horizon – with inflation gathering pace again?

Investors could be forgiven for assuming that rising prices are the last thing they need to worry about given last week's figures.

The retail price index – one measure of inflation – has fallen to zero. In other words, prices remain unchanged compared to a year ago. This has prompted fears that recession may bring about a period of flat, or falling, prices.

But the Government's preferred measure of inflation – the Consumer Price Index – jumped unexpectedly to 3.2pc in February, showing that some prices are still rising ahead of Government targets.

Why is there a difference between these two figures? Put simply, only the Retail Price Index (RPI) takes into account monthly mortgage repayments. These have fallen sharply, thanks to an unprecedented series of interest rate cuts. CPI ignores this data, so there has not been any corresponding decline.

Most experts agree that, for the short term at least, we are in a period of zeroflation or even deflation. But many are warning investors to look to the long term instead.

David Kuo, of the financial website The Motley Fool, said: "It's inflation that investors should be guarding against." Like others, he is concerned that the "bail-out" measures adopted by governments across the world to kick-start the economy, could be storing up future inflationary pressures.

"For example the Government in the UK is now effectively printing money in a bid to ease the credit crisis. Mr Kuo said: "It's likely that once quantitative easing [the printing of money] permeates through the economy, we'll see the rate of inflation begin to rise again."

So what steps should investors be taking now to protect their portfolios?

Protecting against deflation
If you think that the British economy is heading into a protracted downturn akin to the "lost decade" Japan experienced in the Nineties then now is the time to play it safe.

In a period of prolonged depression and falling prices, equities will underperform, as company profits suffer. Instead, investors should look at government gilts and high-quality investment bonds, as these are likely to produce the best returns.

Juliet Schooling, the head of research at Chelsea Financial Services, said: "Gilts are considered the safest market instrument and can provide a safe haven in a deflationary environment. This is because the gilt will pay out a fixed rate of interest which will increase in value as prices fall."
Investors can buy gilts individually or through a fund. Ms Schooling recommends City Financial Strategic Gilt fund, currently yielding 3.33pc.

But Gavin Haynes, the managing director of Whitechurch Securities, said: "Deflationary concerns have pushed gilt prices up and yields have fallen to historically low levels. So unless you think we are entering a long-term deflationary environment, then they are starting to look expensive."

Although equities typically perform badly in deflationary conditions, Jason Collins, a multi manager from Ignis, said investors should not step out of the stock market completely.
"The emphasis should be on selecting 'winning companies'. Look at very defensive sectors that are not sensitive to the economic cycle".

He added that investors may also want to target "the strongest companies in more cyclical sectors that will take market share from the weaker players that fail".

He added: "Deflation is particularly bad for those with big debts and physical assets – so property values are likely to fall and the real value of your mortgage debt will increase."

Adrian Lowcock, senior investment adviser at Bestinvest, said: "In the current climate there are a number of steps investors can take which will benefit them if prices fall, but also make good sense for the long term."

Given that debt increases in real terms in periods of deflation, Mr Lowcock said investors should spare funds to reduce the size of their mortgage.

He pointed out that investors should not overlook cash savings. "With interest rates so low, cash savings can look unattractive. But remember if we enter a period of deflation then in real terms your money is growing by 3pc a year."

http://www.telegraph.co.uk/finance/personalfinance/investing/5063248/Deflation-How-to-protect-your-portfolio.html

Inflation: how to protect your portfolio

Inflation: how to protect your portfolio
If inflation does kick off, then there is one place you want to be: equities.

By Emma SimonLast Updated: 9:35PM GMT 27 Mar 2009

Mr Haynes at Whitechurch said that those taking a medium- to long-term view should not ignore the stock market.

"I particularly favour equity income funds that invest in companies that can pay and grow dividends above the rate of inflation," he added. His preferred choice is Artemis Income or Newton Higher Income.

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Those on a fixed income, such as pensioners, should take care to hedge against inflation, as it can seriously erode future spending power.

It is possible to buy index-linked gilts and index-linked annuities, which typically rise in line with RPI. However, there is often a premium to pay for buying this protection which can leave investors out of pocket if inflation falls.

Interest rates tend to rise in periods of inflation. On the face of it this is good for those with cash savings. But remember, you want to look at real returns – the interest you are getting on your savings, over and above inflation.

A return of 6pc may sound a lot healthier than the 1pc people are typically getting paid today, but if RPI is significantly higher, you may be little better off.

Mr Haynes added: "It may be worth considering commercial property funds again as a hedge against inflation.

"A lot of leases have upwards-only rent review and will increase rents in line with RPI. There could be further pain in the short term as the economic environment worsens, but if inflation rears its head it may be time to revisit these funds."

Hedging your bets

Paradoxically there is one asset that advisers recommend as a hedge against both inflation and deflation: gold. Mr Haynes explains: "Many investors believe gold is a good, safe bet in times of economic turmoil and falling interest rates. However, due to its intrinsic value and limited supply, gold has the ability to retain its real value over time, making it a potential hedge against inflation."

Ms Schooling agrees. "When prices are unstable people feel safer holding gold. Historically it has managed to keep its head in times of economic turmoil."

So whether we enter a period of deflationary gloom, or prices start to rise out of control, gold should be a safe bet. However, there is one word of warning.

Once we come out of the recession and the economic picture becomes more benign, gold is bound to lose is lustre. Investors are unlikely to want such a safe investment, and a change of sentiment could cause prices to dip sharply.

Those wanting exposure to gold can either buy gold bullion, invest in an exchange-traded fund that tracks the gold price, or buy into a fund such as Black Rock Gold and General, which invest in mining and other gold-related shares.

Mr Collins added: "Whichever wins through it's clear we're in for a difficult and uncertain time that will result in higher levels of volatility in financial markets.

"It won't be enough to simply buy an asset class to protect you from the ravages of inflation or deflation." Investors need to be nimble: diversification will remain key, as will keeping an active eye on your investments.

http://www.telegraph.co.uk/finance/personalfinance/investing/5063296/Inflation-how-to-protect-your-portfolio.html

How Do Banks Make Profits?

How Do Banks Make Profits?
Traditional Centers of Bank Profits
© Carmelo Montalbano

Mar 27, 2009
Bank earnings are derived from four main operations: Loans and fees from lending operations, trading profits in bonds, trust department activities, investment banking.

.The basis for a bank's importance is its power to lend. The lending function matches institutions with excess liquidity with those in need of capital on a temporary, or intermediate term. The bank acts as the arbitrator of credit, understanding risk in order to lend, showing economic resilience in order to attract lenders.

Spread Lending Creates Opportunity
The basis for bank lending is their ability to collect deposits primarily through checking accounts, savings accounts, and certificates of deposit. In the last few years short term borrowing have been a major source of funding. This is possible in part because the yield curve is positively sloped giving banks a further advantage if they borrow short but extend their lending horizon. This deposit base is then lent out at a higher interest rate for loan origination and trading and portfolio operation. This lending arbitrage is called the 'spread.' The powerful ability to lend fuels the profitability of banking activities because banks can provide immediate loan resources for any banking deal they originate that requires such financing.

It is the spread that funds credit card lending, mortgage lending, corporate lending, lines of credit and foreign credit. It is from the arbitrage opportunity that reserves are taken for bad debt and 'impairments' or the temporary inability of a creditor to meet interest and principle payments.

Banking Fees and Investment Banking Activities
Advising banking clients and aiding them in financing their strategic plans is a natural result of the bank's lending activity. Investment banking includes the ability to earn fee income from municipalities, foreign governments, corporations, and international agencies. Advising clients is a natural opportunity for banks because as part of the lending function banks know the intimate details of a company's balance sheet and plans. Banks serve as consultants in mergers, acquisitions, public debt issuance and restructuring, real estate construction and financing, and leasing and corporate loan origination.

The Trust Function
Separate from other banking activities are trust activities. Trust is the wealth building and preservation business where, for a fee, banks advise high net worth individuals and companies on their retirement plans and savings. In addition to advisement banks may offer trust services where funds are invested by professional advisers into wealth building assets. This function resembles that of mutual funds but it is usually done on an individual, customized basis. Banks also provide custodial services whereby the bank acts as the intermediary between stockholder and bondholder providing payment services for interest, dividend and principal payments.



Read more: "How Do Banks Make Profits? Traditional Centers of Bank Profits" - http://investment-banking.suite101.com/article.cfm/how_do_banks_make_profits#ixzz0B6tEiiDC

***Not making money to maintain his retirement lifestyle.

2008/08/09

YAP MING HUI: Hedging against inflation


IT was an anxious Jimmy that came to see me about a year after he retired. He had sold his factory to a US company.

At our first meeting, I asked him how his retirement life was. He said: "Everything is fantastic. I get to travel a lot and play golf."

However, there was a problem.

"I need to break my fixed deposit every now and then to maintain my lifestyle."

Jimmy has about RM10 million but most of his investments in property, unit trusts and shares were not making money to maintain his retirement lifestyle.

He has about RM4 million in fixed deposit. But the interest income from fixed deposit barely covers the impact of inflation.

If he were to spend the interest income, he will risk having the principal depleted over the years due to inflation.

What is the problem?

Jimmy's problem is a typical case of "asset rich, income poor" -- people who are good at creating wealth from their business or profession but weak at generating income from the created wealth. They are rich in assets which are not generating good investment income.

Jimmy's total wealth is RM10 million. His RM4 million generates four per cent of interest.

However, four per cent of interest is not enough to cover the four per cent of inflation provision. As a result, there is no net income for Jimmy from his fixed deposit asset.

His RM3 million of properties generates a RM50,000 income per annum. This can be considered a net income for him because inflation will be hedged by the capital appreciation of at least four per cent per annum.

His RM1 million of shares give him a total return of nine per cent. After the provision of four per cent inflation, his actual income is RM50,000.

His RM2 million unit trust investment didn't make him any money at all.

Therefore, the total actual income after inflation is RM100,000. Due to the fact that Jimmy needs RM400,000 to maintain his lifestyle, he is short of RM300,000 of annual income.

Solution

- Review the performance of each investment asset classes

Jimmy needs to review the performance of all his investments. He will need to get rid of poorly performing investments. He will need to look at each unit trust fund and property to decide if he should sell or keep them.

- Move fixed deposit into higher return investment

Jimmy's fixed deposit will be eroded by inflation if he continues to leave that much of his wealth under fixed deposit.

After calculating and providing for his short-term cash flow needs, the balance of his fixed deposit should be in other investments that are able to generate higher return to hedge against inflation.

- Diversify retirement income

Just because one investment asset gives you good income and a hedge against inflation, it doesn't mean that you must put all or the majority of your wealth into it.

Some people have been successful in property investing. They managed to generate good capital appreciation and rental income. However, rental income is not necessarily sustainable in the long run and is normally subject to a lot of changes.

Therefore, the best practice is still to diversify your retirement income so that it is not badly affected by any one source.

One should consider also share dividends and capital gains, unit trust gains, bond investment gains and retirement income products.

Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2315138/Article/index_html

If this rally is the real McCoy, most people will miss out

If this rally is the real McCoy, most people will miss out
Winter on the markets could finally be ending, but it will take time for investors to shed their bearskins.

By Tom Stevenson
Last Updated: 10:25AM GMT 26 Mar 2009

Comments 5 Comment on this article

Perhaps it was all that gloriously unseasonal weather last week. It's hard to maintain a bearish scowl in the face of catkins, daffodils and blue skies. Whatever the reason, investors have had a spring in their step on both sides of the Atlantic. The obvious question is whether the 22pc two-week gain on Wall Street, or the rather more subdued 13pc three-week rise over here, is just another bear market rally or the real McCoy.

The US reversal has certainly been spectacular, especially the Geithner-inspired 7pc surge in the S&P 500 on Monday. That was the fifth biggest one day rise and the best performance in a single session since last autumn's gyrations. Over here things don't look quite so special – we've been here several times already during this bear market.

Since the FTSE 100 peaked in June 2007, there have been four rallies of 10pc or more. The first was the phony war between August and October 2007 when we kidded ourselves that the problem was "over there" and could be contained in the financial and property sectors. Shares rose by 15pc.

Next was the 18pc Bear Stearns relief rally between March and May last year. Phew, we thought, that gets all the bad news out of the way. There was another 10pc rise in the holiday lull before the collapse of Lehman Brothers ensured that all bets were off in September and October.
Finally the year ended with a 15pc act of collective self-delusion when we thought the "real economy" might escape the worst effects of the credit crunch. Even as investors were crossing their fingers, the economy was in fact falling off a cliff.

So why should the latest bounce be any different? The rise so far is bang in line with the other rallies that came to nought. Why shouldn't it also peter out when investors find something new to worry about?

The first reason is that, with every downward lurch, the valuation argument becomes ever more compelling. Yes, shares have been cheaper but on increasingly few occasions. Buying shares when they have been available at the current multiple of earnings has in the past given investors a better than evens chance of achieving a 10pc a year return for a decade or more.

So even if this doesn't turn out to be the actual bottom of the market, on any sensible timescale for buying shares any further short-term losses are likely to be quickly clawed back. The more people who realise that this is the case, the more likely it is that this will indeed be the bottom.

The second reason to think the low point is near is the sheer length and depth of the bear market. The dot.com crash was longer but we've already matched the scale of drop. Only the 1970s and 1930s come close in size and duration.

Third, the market is holding up in the face of bad news, the best sign of all that the gloom and doom is already in the price. It is hard to imagine the market shrugging off Mervyn King's comments about the dire state of the public finances six months ago.

Finally, there are some tentative signs that the economy, if not exactly improving, is deteriorating less quickly than it was. Bear markets do not end when things get better but when they stop getting worse.

Signs to watch out for are things like the copper price – up by a third so far this year – and the Baltic Dry Freight index, which has risen sharply. Another straw in the wind is the very low level of inventories companies are holding. The smallest uptick in demand will immediately feed through into higher industrial production, so economic expectations might even be exceeded rather than endlessly disappointed later this year.

Another positive to note about the jump in share prices in March was the breadth of the rally. The ratio of risers to fallers exploded in this month's rally, a classic signal that we have seen a real low rather than what the traders call a "dead cat bounce".

Of course, no one knows whether March 2009 will mark the bottom or not, but if it proves to be the low point one thing is certain: most people will miss it. Data from the US shows that the ratio of cash held in money market funds compared to mutual fund assets peaked more or less as the market hit rock bottom in 2002. The stock market had risen by 30pc over the subsequent 15-month period before cash levels had returned to average so most people got back into the market way too late.

That wouldn't matter if bull markets were steady affairs adding value smoothly from trough to new peak. But they are not. It has been calculated that more than a quarter of the total return from all the bull markets since 1930 came within the first six months of the bottom of the market being reached. A third came within nine months.

One of these warm spells will really mark the end of winter. How long will you keep your coat on?

Tom Stevenson writes on investment for Fidelity International. The views expressed are his own.

http://www.telegraph.co.uk/finance/comment/tom-stevenson/5050205/If-this-rally-is-the-real-McCoy-most-people-will-miss-out.html

Gilts: what are they?

Gilts: what are they?
A guide to Government gilts.

Last Updated: 12:26PM GMT 26 Mar 2009

What is a gilt?

Gilts are bonds issued by the Government to raise money. The term originated in Britain and referred to debt securities that had a gilt (or guilded) edge.

Who issues them?

Since April 1998 gilts have been issued by the Debt Management Office on behalf of HM Treasury.

Is their more than one type of gilt?

Yes. Conventional gilts are the simplest form of government bond and are the largest share of liabilities in the Government's portfolio. They guarantee to pay the holder a fixed cash payment - or coupon in bond jargon - every six months until the bond matures, at which point the holder receives the final coupon payment and get his original investment back. An investor who holds £1,000 nominal of 4pc Treasury Gilt 2016 will receive two coupon payments of £20 each on 7 March and 7 September until it expires in 2016.

There are other types such as index-linked gilts (IGs), which form the largest part of the gilt portfolio after conventional gilts. Here the coupon is related to movements in the Retail Prices Index (RPI) - in other words, it is linked to inflation.

How do you buy them?

Gilts can either be bought directly from the DMO at its outright gilt auctions or through the secondary market. Bidders at auction can choose to participate through a Gilt-edged Market Maker (GEMM) - a form of broker - who can bid directly by telephone to the DMO on the bidder’s behalf, or by completing an application form, providing that they are members of the DMO’s Approved Group of Investors.

Who buys them?

Anyone can buy gilts. Pension funds are by far the biggest buyers as they need to meet payments when people retire. They are also used by individuals who are looking for a steady income or as part of a balanced investment portfolio.

Source: DMO

http://www.telegraph.co.uk/finance/economics/5054206/Gilts-what-are-they.html

US backing for world currency stuns markets

US backing for world currency stuns markets
US Treasury Secretary Tim Geithner shocked global markets by revealing that Washington is "quite open" to Chinese proposals for the gradual development of a global reserve currency run by the International Monetary Fund.

By Ambrose Evans-Pritchard
Last Updated: 8:18AM GMT 26 Mar 2009

The dollar plunged instantly against the euro, yen, and sterling as the comments flashed across trading screens. David Bloom, currency chief at HSBC, said the apparent policy shift amounts to an earthquake in geo-finance.

"The mere fact that the US Treasury Secretary is even entertaining thoughts that the dollar may cease being the anchor of the global monetary system has caused consternation," he said.

Gold price spikes as dollar falls Mr Geithner later qualified his remarks, insisting that the dollar would remain the "world's dominant reserve currency ... for a long period of time" but the seeds of doubt have been sown.

The markets appear baffled by the confused statements emanating from Washington. President Barack Obama told a new conference hours earlier that there was no threat to the reserve status of the dollar.

"I don't believe that there is a need for a global currency. The reason the dollar is strong right now is because investors consider the United States the strongest economy in the world with the most stable political system in the world," he said.

The Chinese proposal, outlined this week by central bank governor Zhou Xiaochuan, calls for a "super-sovereign reserve currency" under IMF management, turning the Fund into a sort of world central bank.

The idea is that the IMF should activate its dormant powers to issue Special Drawing Rights. These SDRs would expand their role over time, becoming a "widely-accepted means of payments".

Mr Bloom said that any switch towards use of SDRs has direct implications for the currency markets. At the moment, 65pc of the world's $6.8 trillion stash of foreign reserves is held in dollars. But the dollar makes up just 42pc of the basket weighting of SDRs. So any SDR purchase under current rules must favour the euro, yen and sterling.

Beijing has the backing of Russia and a clutch of emerging powers in Asia and Latin America. Economists have toyed with such schemes before but the issue has vaulted to the top of the political agenda as creditor states around the world takes fright at the extreme measures now being adopted by the Federal Reserve, especially the decision to buy US government debt directly with printed money.

Mr Bloom said the US is discovering that the sensitivities of creditors cannot be ignored. "China holds almost 30pc of the world's entire reserves. What they say matters," he said.

Mr Geithner's friendly comments about the SDR plan seem intended to soothe Chinese feelings after a spat in January over alleged currency manipulation by Beijing, but he will now have to explain his own categorical assurance to Congress on Tuesday that he would not countenance any moves towards a world currency.

http://www.telegraph.co.uk/finance/economics/5050407/US-backing-for-world-currency-stuns-markets.html

Will You Be Satisfied With 7% Returns?

Will You Be Satisfied With 7% Returns?
By Alex Dumortier, CFA
March 18, 2009 Comments (41)

7.2%.
That's what Jeremy Grantham recently predicted stocks will return -- after inflation -- on an annualized basis over the next seven years.

Is that good enough for you?
Who on earth is Jeremy Grantham? Jeremy Grantham is the co-founder of investment firm GMO, which currently has approximately $90 billion in assets under management.

Grantham is often dismissed as a "perma-bear" when his views go against Wall Street's institutionalized optimism -- but the truth is, he's a rock-solid investment thinker, grounded in reality, who calls 'em like he sees 'em.

He believes that "mean reversion is the most powerful force in financial markets." In other words, periods of abnormally high returns must be balanced out by periods of abnormally low returns, and this holds true across the gamut of different assets, whether it be commodities, stocks, or bonds.

On that basis, at the end of 2001, Grantham predicted that the S&P 500 would suffer an annualized decline of 1.1% over the following seven years -- which was decidedly optimistic, since the annualized real return turned out to be negative 3.9%.

In July 2007, as the credit crisis was in its infancy, Grantham wrote: "In five years, ... at least one major bank (broadly defined) will have failed." We've all witnessed the multiple failures, rushed takeovers, and government rescues in the financial sector since then.

So, it's worth taking his predictions seriously.

7%? Seriously?
It may be hard to imagine 7% annual returns (after inflation, no less!) right now, what with the S&P 500 down approximately 50% from its all-time high in October 2007, but that decline has, in fact, set the stage for investors to earn 7% -- near the average historical return on stocks -- going forward.

The drop has been a source of enormous pain for investors -- but from the point of view of the prospective stock buyer, it's a great opportunity since stocks are at lower valuations than they have been in years.

In fact, Grantham called U.S. blue chips "manna from heaven"; indeed, when the credit crisis began to escalate, he said "they were about as cheap, on a relative basis, as they ever get."
I wanted to verify that claim, and I was able to confirm that over one in four non-financial stocks in the S&P 500 are cheaper in terms of their price-to-book value multiple than they have been in over 14 years. They include these superb companies:

Price/Book Value
Forward Price/Earnings

Oracle (NYSE: ORCL)
3.3
10.4
Cisco Systems (Nasdaq: CSCO)
2.5
14.5
Procter & Gamble (NYSE: PG)
2.3
12.7
eBay (Nasdaq: EBAY)
1.3
8.4
CVS Caremark (NYSE: CVS)
1.1
12.3
General Electric (NYSE: GE)
1.0
8.1
Alcoa (NYSE: AA)
0.4
N/A
Source: Capital IQ, a division of Standard & Poor's, as of March 16, 2009.

But what if you aren't satisfied with 7% returns?

Getting to 7% *plus*
Grantham's prediction is based on the S&P 500, in aggregate, being fairly valued (he's currently pegging its fair value at 950). And if you pay fair value for the index, you can expect to earn the weighted average return that the underlying companies earn on their equity.

But within the S&P 500, some stocks will likely be overvalued, and some will likely be undervalued. If you're able to buy an individual stock for less than its fair value, that margin of safety will turbo-charge your expected return beyond the company's accounting return on shareholders' equity.

Grantham expects a subset of U.S. stocks -- those he labels "high quality" -- to produce after-inflation annualized returns of 11.2% over the next seven years. Four percentage points on an annualized basis is an enormous difference -- and gives investors plenty of incentive to identify those "high quality" stocks.

Although Grantham doesn't directly define "high quality," he provides some clues in an interview with Forbes in which he said, "And the best bet, for my money, then and now, a year later, was to buy the great franchise companies, the great quality companies." This suggests that he favors companies that possess a moat -- a sustainable competitive advantage -- and that earn excess returns over their cost of capital.

Helping you earn better returns
No investor is "condemned" to 7% returns going forward -- and neither are we promised them. Investing -- at reasonable prices -- in excellent businesses that are likely to grow is the best strategy for securing your long-term returns.

Of course, even among stocks that are perceived as "high quality," you can expect a range of different returns. The trick is identifying which stocks are genuinely undervalued.


Alex Dumortier, CFA has no beneficial interest in any of the companies mentioned in this article. Procter & Gamble is a Motley Fool Income Investor pick. eBay is an Inside Value and a Stock Advisor recommendation. The Fool owns shares of Procter & Gamble.

Read/Post Comments (41)

http://www.fool.com/investing/value/2009/03/18/will-you-be-satisfied-with-7-returns.aspx

How You Can Tailor-Make a Winning Portfolio

How You Can Tailor-Make a Winning Portfolio
By Dan Caplinger March 25, 2009

Anybody can throw a bunch of investments together and call it a portfolio. It takes a lot more, however, to find a select group of promising prospects that fit well with your temperament, your time horizon, and your particular financial goals.

Too often, investors don't think about their investment portfolio as a single unit. Instead, they grab shares of various stocks and funds willy-nilly, based solely on their individual characteristics -- never thinking of a new stock's impact on the holdings they already own.

Make the right portfolio
In this month's brand-new issue of Motley Fool Champion Funds -- which goes live this afternoon at 4 p.m. EDT -- Foolish fund expert Amanda Kish takes a look at this question from a unique angle. Part of what Amanda's newsletter offers subscribers every month are three model portfolios, each of which represents a blend of some of the funds that the service has recommended over the years.

But of course, unless you're just getting started with your investing, you'll probably already have some stocks and funds to bring to the mix. In addition, even if you have cash available, you may not have access to buy the exact funds you want -- especially if you have to choose from a fixed menu of investment options, as many workers must in their 401(k) plans.

Given those limitations, what's the best way to choose investments in a way that will complement your existing portfolio rather than create problems?

Watch out for the concentration trap
With individual stocks, problems often come from haphazardly choosing promising companies that aren't well diversified. For instance, here's an extreme example of stocks you might have been tempted to add to your portfolio based on these news items from early last year:

• With the discovery of a massive oil field off the cost of Brazil, Petroleo Brasileiro (NYSE: PBR) found itself fortuitously positioned to take maximum advantage of the news.
• The red-hot Haynesville shale play brought quick profits to natural gas players like Petrohawk Energy (NYSE: HK) and Chesapeake Energy (NYSE: CHK).
• Demand for fertilizer rose much faster than supply, giving industry players like Potash Corp. (NYSE: POT) and Mosaic (NYSE: MOS) great returns during the first six months of 2008.
• Early in 2008, heavy demand for industrial metals from China and other development-hungry economies bolstered prospects for copper producers like Southern Copper (NYSE: PCU) and Freeport-McMoRan (NYSE: FCX) -- and with China's economy forecast to grow strongly, the end seemed far away.

Clearly, if you'd acted on those temptations, you would've owned a portfolio that was way overweighted in energy and commodities stocks -- stocks that came crashing down during the latter half of the year.

Dealing with funds
With mutual funds, there are a bunch of things to keep in mind when tailoring a fund portfolio for your particular wants and needs. For instance:

• If you have a strong relationship with a particular fund company, you might want to use their offerings in particular asset classes rather than mixing and matching across different fund companies.
• Even within broad categories like large-cap value or small-cap growth, you'll find dozens of different strategies. Some may appeal to you more than others, even if all of them have been equally successful at creating gains over the long haul.

Champion Funds gives portfolio recommendations for conservative, moderate, and aggressive investors. But if you find yourself halfway between two of those categories, then an easy way to split the difference may be to add another fund.

In this month's newsletter, Amanda goes through these and other reasons you may have for making switches -- and gives you a useful set of tools to help you evaluate whether a particular fund you may have in mind is the right one to keep your overall portfolio strong. And with dozens of different fund recommendations to choose from, Champion Funds subscribers don't have any shortage of great funds to plug into their overall investment strategy.

Putting together a tailor-made portfolio will take some work, but the rewards will last a lifetime.

For more on winning investment strategies, read about:
Yes, you can defend your portfolio from losses.
Will 7% returns really make you happy.
Want to retire? You need options.

Fool contributor Dan Caplinger is constantly making adjustments to his portfolio. He owns shares of Freeport McMoRan and Chesapeake Energy. Petroleo Brasileiro is a Motley Fool Income Investor pick. Chesapeake Energy is a Motley Fool Inside Value recommendation.

http://www.fool.com/investing/mutual-funds/2009/03/25/how-you-can-tailor-make-a-winning-portfolio.aspx

Pyramid Your Way To Profits

Pyramid Your Way To Profits
by Cory Mitchell (Contact Author Biography)


Pyramiding involves adding to profitable positions to take advantage of an instrument that is performing well. It allows for large profits to be made as the position grows. Best of all, it does not have to increase risk if performed properly. In this article, we will look at pyramiding trades in long positions, but the same concepts can be applied to short selling as well.


Misconceptions About Pyramiding

Pyramiding is not "averaging down", which refers to a strategy where a losing position is added to at a price that is lower than the price originally paid, effectively lowering the average entry price of the position. Pyramiding is adding to a position to take full advantage of high-performing assets and thus maximizing returns. Averaging down is a much more dangerous strategy as the asset has already shown weakness, rather than strength. (For further reading, see Averaging Down: Good Idea Or Big Mistake?)Pyramiding is also not that risky - at least not if executed properly. While higher prices will be paid (in the case of a long position) when an asset is showing strength, which will erode profits on original positions if the asset reverses, the amount of profit will be larger relative to only taking one position.

Why It Works

Pyramiding works because a trader will only ever add to positions that are turning a profit and showing signals of continued strength. These signals could be continued as the stock breaks to new highs, or the price fails to retreat to previous lows. Basically, we are taking advantage of trends by adding to our position size with each wave of that trend.

Pyramiding is also beneficial in that risk (in terms of maximum loss) does not have to increase by adding to a profitable existing position. Original and previous additions will all show profit before a new addition is made, which means that any potential losses on newer positions are offset by earlier entries. Also, when a trader starts to implement pyramiding, the issue of taking profits too soon is greatly diminished. Instead of exiting on every sign of a potential reversal, the trader is forced to be more analytical and watch to see whether the reversal is just a pause in momentum or an actual shift in trend. This also gives the trader the foreknowledge that he or she does not have to make only one trade on a given opportunity, but can actually make several trades on a move.

For example, instead of making one trade for a 1,000 shares at one entry, a trader can "feel out the market" by making a first trade of 500 shares and then more trades after as it shows a profit. By pyramiding, the trader may actually end up with a larger position than the 1,000 shares he or she might have traded in one shot, as three or four entries could result in a position of 1,500 shares or more. This is done without increasing the original risk because the first position is smaller and additions are only made if each previous addition is showing a profit. Let us look at an example of how this works, and why it works better than just taking one position and riding it out.

Real-World Application

For simplicity, let's assume we are trading stocks for our first example, and have a $30,000 trading account limit. The maximum we want to risk on one trade is 1-2% of our account. Using a 1% maximum stop, in dollar terms we are only willing to risk $300. A stop will be placed on the trade so that no more than this is lost. We look at the chart of the stock we are trading and pick where a former support level is. Our stop will be just below this. If the current price is 50 cents away from the last support level and we add a small buffer (so, 55 cents), we can take 545 shares ($300/$0.55=545). Round this number down and only take 500 shares; our risk in now less than $300. We could buy our 500 shares and hang on to them, selling them whenever we see fit, or we could buy a smaller position, perhaps 300 shares, and add to it as it shows a profit. If the stock continues to trend, we will end up with a larger position (and thus more profit) than 500 shares, and if the stock falls we only lose money on 300 shares - a loss of only $165 ($0.55*300) as opposed to $275 ($0.55*500) if we only took a static 500 share position.Now, let's take a look at an example using a 15-minute chart of the Great Britain pound against the Japanese yen (GBP/JPY). The circles are entries and the lines are the prices our stop levels move to after each successive wave higher.

Figure 1: November 4, 2008
Source: ForexYard

In this case, we will use a simple strategy of entering on new highs. Our stops will move up to the last swing low after a new entry. If a stop price is hit, all positions are exited. Our entries are 155.50, 156.90, 158.10 and 159.20 as we add to our position with each successive move to new highs after a reversal. The latest reversal low gives us an original stop of 154.15 and then progressively 155.50, 157.00, 157.50. Finally, we have a reversal and the market fails to reach its old highs. As this low gives way to a lower price, we execute our stop at order at 160.20, exiting our entire position at that price. (For more, see Is Pressing The Trade, Just Pressing Your Luck?)

The Verdict

Assume we can buy five lots of the currency pair at the first price and hold it until the exit, or purchase three lots originally and add two lots at each level indicated on the chart. The buy-and-hold strategy results in a gain of 5 x 470 pips, or a total of 2,350 pips. The pyramiding strategy results in a gain of (3 x 470) + (2 x 330) + (2 x 210) + (2 x 100) = 2,690 pips. This is almost a 15% increase in profits, without increasing original risk. This can be further increased by taking a larger original position or increasing the size of the additional positions.

Problems With Pyramiding

Problems can arise from pyramiding in markets that have a tendency to "gap" in price from one day to the next. Gaps can cause stops to be blown very easily, exposing the trader to more risk by continually adding to positions at higher and higher prices. A large gap could mean a very large loss. Another issue is if there are very large price movements between the entries; this can cause the position to become "top heavy," meaning that potential losses on the newest additions could erase all profits (and potentially more) than the preceding entries have made.

Final Notes

It is important to remember that the pyramiding strategy works well in trending markets and will result in greater profits without increasing original risk. In order to prevent increased risk, stops must be continually moved up to recent support levels. Avoid markets that are prone to large gaps in price, and always make sure that additional positions and respective stops ensure you will still make a profit if the market turns. This means being aware of how far apart your entries are and being able to control the associated risk of having paid a much higher price for the new position. (For more on preventing losses, see A Logical Method Of Stop Placement.)

by Cory Mitchell, (Contact Author Biography)Cory Mitchell is an independent trader specializing in short- to medium-term technical strategies. He is the founder of http://www.vantagepointtrading.com/, a website dedicated to free trader education and discussion. After graduating with a business degree, Mitchell has spent the last five years trading multiple markets and educating traders. He has been widely published and is a member of the Canadian Society of Technical Analysts and an affiliate of the Market Technicians Association.

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