Posts Tagged ‘investment’

The arena of high yield investments is technically very difficult for many to understand. The reason for this is the “term high yield investments” typically refers to a particular class of bond investment and as a whole, bonds are difficult to fully understand. And this does not relate solely to the inverse relationship between rates and price; it refers to the broader spectrum of bond analysis.

Luckily, there are bond funds available on the market that are not only highly ranked within the industry, but come with an intelligent analysis department that takes all of the hard number crunching and the complex chore of making heads and tails out the myriad of connected economic statistics off of your hands and drops those problems on someone else’s lap (someone who is paid a decent salary until you factor in the overtime).

Now, just because the term bonds is often linked to that attractive arena known as high yield investments does not mean that the risk is limited. Of course, in the most sense risk is minimal as bonds will be rated by independent rating agencies like Standard and Poors and Moody’s. And yes, bonds will have a security value attached to them (compared to common stock which lays no claim on any assets) . And yes, bonds are secured creditors which means they are to be paid ahead of any unsecured claims in the event of liquidation.

But bonds fluctuate. And even the best high yield investments, including the top-ranked bond funds will outperform the overall markets in times of both bull and bear periods. Even these top-ranked bond funds will have beta that exceed the market-standard of 1 (Beta is a measurement of how much a security or investment will fluctuate given changes in the stock market. For example, an investment with a beta of 1 will match the market movement, whereas an investment of 1.2 will  move 1.2 times the movement in the market… so, all things being equal, a market move of 4% will mean a move of 4.8% for the investment with a 1.2 Beta).

Knowing this, many investors still see high yield investments as a fairly risky proposal and opt instead for locked-in, inflexible term deposits at rates that rarely, if ever, exceed the consumer price index, or inflation rate.

The argument here is actually FOR high yield investments, particularly as an alternative to higher risk equity funds and lower risk (are they?) and lower-rate term deposits. The reasons are plenty, but we will touch on a few right here:

>> High Yield Investments are liquid. Just like your equity funds, a high yield bond fund will allow you to liquidate at any time and at no cost (note: this does not include any loads that may or may not be charged by the fund company).

>> High Yield Investments are secured by assets in most cases. Unless you are looking at a junk-bond class of investment, most bonds in this category are acceptable risk, meaning their assets are in place and, usually, contributing to revenues.

>> High Yield Investments are closely monitored by fund companies. Of course, this is speculation, but many top-ranked high yield bond funds will have turnover rates greater than 100%, meaning they turn over their entire portfolio, on average, at least once per year. As well since high yield investments are actually below investment grade, meaning BB or lower, the fund company will review their holdings regularly to ensure the risk of default is minimized. (Remember, this higher risk as deemed by the rating companies is what justifies the high rates paid on these bonds). One particular high yield bond fund hold companies like Ford, Teck Resources and Dole Foods among its Top 10 holdings and none of these bonds pays less than 7.45%

These three arguments are rather convincing for most investors. Companies like Ford, for example, may default on a bond payment but the consequences could mean losing a piece of equipment. With investors fighting for automotive assets (think of Magna, the Russians, etc. to start) it seems unlikely that even a highly specialized piece of equipment could lose enough value that bond holders are stuck with scrap as security.

Regardless, high yield investments provide some indisputable advantages over common equity funds. While there is no ownership claim for bond holders, there is a tangible asset that protects bond holders against complete loss. Additionally, bond holders are normally paid a guaranteed rate of income. In practical terms, high yield investments are often just as liquid as shares or equity funds, meaning that they can be cashed in when the funds are needed, unlike term deposits which most often cannot (not without fees and penalties). Most importantly, high yield investments provide greater income opportunities for investors.

Once you have decided to invest money, whether you invest in individual securities or mutual funds, whether you invest $100 million or $100 per month, you will find yourself immersed in the domain of investment management.  For most, this idea is either a welcome change to their existing routine or it is a frightening thought (often exceedingly frightening).

However, investment management need not be such a daunting concept. In fact, it can rather simple if you have the right people working for you (and in the case of mutual fund investments, before you invest so much as a single cent with a fund manager, you are essentially “convinced” that you are working with the right people).

Of course, investing in a mutual fund makes the task of investment management quite a bit simpler. However, there are still some very basic tasks you should endeavor to complete every quarter at the very least to ensure that your original investment objectives are not only being met by your current investment portfolio but that those investments have not made fundamental changes to their individual approach, objectives, risks and strategy. In some cases, this can be as simple as going back to the Prospectus that is published annually by the fund company and exploring their Fund Objective.

Remember, when your investment advisor recommends a fund (or you find one yourself that meets your individual investment objectives and fits within your total asset allocation model) your decision will often be predicated by how well the fund’s objective can help you achieve yours. Therefore, if the fund’s objective changes then you could see a fundamental change to its performance and an obvious change to how that specific fund will contribute to your own investment objectives.

In addition to Fund Objective, some of the key areas of focus when it comes to your investment management tasks should be:

Management Profile – has it changed? If so, why? You can find this information primarily in the Prospectus or on popular analysis sites like Morningstar, but if there has been a change then you will want to investigate by digging deeper on the fund company’s website and searching its press releases. Understand the cause behind the change and determine as best as you can whether such a change can be tolerated by your portfolio.

Market Performance versus Index and Category.  If your fund has been able to exceed Index and Category returns consistently over the past 3 years but all of a sudden has fallen behind, understand why. If the fund in question has a high beta (meaning it is more sensitive than the market’s fluctuations) then that might be sufficient during times of poor market performance. However, if the markets are steady as a whole and your fund underperforms, what is the reason? What caused this instance of under-performance and are such changes acceptable to your portfolio? Again, Morningstar does a great job of analyzing fund performance against index and category.

How has the underlying Portfolio changed in the fund, if at all? This part is a little more involved and requires a bit of digging on the investor’s part, but is extremely vital. Remember that your investment decision was based on several factors, including asset allocation, management style and investment quality. You should understand if any of these factors have changed considerably since you made your purchase or last-reviewed the fund. If there have been changes to any of these three areas (asset allocation, investment style and investment quality) you will need to re-evaluate and/or re-balance the rest of your portfolio. Often, it is simply easier to replace the offending fund with another (there are plenty) that meets the original investment requirements. However, it is strongly advised that you understand the basis for the change before making hasty trades in and out of a fund and since most fund companies will provide management commentaries about such fundamental changes such information is often easily obtained.

Unfortunately, it may seem from the above that the task of investment management is still fairly complicated . This is actually quite far from the truth. With the resources available online, the “chore” can be rather illuminating and educational. Most importantly, it allows investors to get a deeper understanding of the funds and investments that are intended to help them achieve their financial goals. To recap, investment management when it comes to a mutual fund portfolio can be as simple as:

>> Reviewing the Fund’s Objective

>> Understanding changes in fund management, if any.

>> Comparing fund performance to index and category performance and investigating changes in trends.

>>  Reviewing changes and abnormalities in the fund’s underlying portfolio of securities.

It can be argued that asset allocation is the single-most important aspect to investment planning. But interestingly enough, too many people skim through the process of building the right asset allocation model for them. This should never be the case. Here are some of the biggest reasons why asset allocation is so important.

Market Timing Becomes Irrelevant. The most basic premise to financial planning is establishing, well, a plan. This plan can be summed up as financial goals (e.g. “I need $2 million”, time goals “I need it in 15 years,” and risk goals “I need to survive the stress of investing between now and then”) that translate into asset allocation. For example, large investment goals with modest savings will result in the need for greater growth components compared to fixed income. With asset allocation on your side, you will no longer worry about the individual weightings as you will stay the course. Timing entry and exit points is less relevant.

As well, sticking to an asset allocation plan will allow the investor to avoid buying in when markets are hot and bailing out of cooler markets when other asset classes seem more appealing. This is particularly true after the last few years; while many people might have wanted to bail out of the market in March 2009, they would have missed out on the exponential gains since. The right asset allocation model deters people from making such decisions as market timing is no longer a factor.

Exposure Limits Determine Trading Decisions. By incorporating the right asset allocation model, you essentially put together a mission statement for your investment portfolio. While some Fund of Funds portfolios will automatically rebalance your portfolio for you, other investments will require some effort on your part to ensure that you are never more exposed to any given asset class. This is particularly important during times of high market volatility. When markets rise by a certain acceptable factor (some will use 10% as a guide while others will rebalance based on time such as daily, weekly, quarterly, etc.) then it could be time to rebalance. For example, 2008 saw tremendous downward market volatility which left the fixed-income over-exposed and equities under-exposed. This meant that investors would trim their fixed income holdings to invest in equities. In the case of 2008, the balance was thrown off by dropping equity prices. Often, the case for rebalancing is made when equity prices increase exponentially during strong market booms.

Risk Tolerance. When building your asset allocation model, one of the greatest considerations will be risk tolerance. This is key because risk often dictates the type of investments people make. By following your model throughout your investment career, the risk factors are balanced within your portfolio, so certain investments that may be higher risk are offset by investments that are lower risk.

Again, the key to a successful investment program is asset allocation. We will look at this more closely in the asset allocation model section, which provides greater examples and illustrations for particular investor profiles.

So you have spent a good hour or so with your trusted Financial Planner discussing risk, objective, time horizon and so forth. You may have had a bathroom break to give the discussion and question more thought, but ultimately the question will come: Where To Invest?

Deciding where to invest is not an easy question to answer. Unfortunately, most people rely quite heavily on recommendations from their planner. However, keep in mind  that like you, your planner will have certain biases about where to invest your money. Some planners like China, others do not. Some like mutual funds, others recommend Exchange Traded Funds (ETFs). But one thing that will not change is that you are the one who ultimately decides where to invest your funds.

With that in mind, some of the different things to consider when the question comes up is:

Asset Allocation: Deciding where to invest should be a question of asset allocation. After all, when building your asset allocation model you will likely come up with an appropriate investment plan. You will have an idea on the types of investments you need to incorporate into your portfolio.

Type of investment: While mutual funds are a natural starting point for many investors, finding one that meets your requirements is another matter. For others, specific securities will more adequately meet their guidelines. Ideally, finding the right type of investment should be a first step. Of course, you want to make sure there is little overlap in investment so that you are not being over-exposed to any given security or asset class.

Geography: Finding where a specific investment is based, either corporately or where it primarily operates is another starting point. Again, making sure that the potential investment meets your asset allocation objective is ideal in ensuring you are not over-exposing your investments to particular geographic regions or areas.

Industry/Sector: Understanding the where the potential investment earns a dime is important. For whatever reason, you may be biased for or against certain industries or sectors. Some investors with a manufacturing background might be more or less inclined to invest in specific manufacturing sectors based on their experience with their own employer. Again your asset allocation will take such things into account.

Currency Exposure. While some investments do not allow foreign currency securities, allowing yourself to be properly diversified in terms of currency risk should also be part of your asset allocation model. Companies that operate in foreign countries will present specific foreign currency risks (and diversification) based on the conversion needed to complete domestic financial statement data. While this is less of a concern for a single security within a large pool of funds, it is certainly a factor when building your own portfolio of individual securities. You can achieve currency balance through all types of investments, however, including mutual funds, bonds, specific securities, as well as forex-based ETF and other securities.

Deciding where to invest should take the above into account. Sitting down with your financial planner is normally the easiest because your planner will (or should) understand such intricacies. However, when it comes to planning out your own individual investments, you would be served by starting a spreadsheet that can be categorized and color-coded to ensure you are not just looking at where places to invest but the right places to invest.