Portfolio Construction 101: Ready Player One
Constructing your investment portfolio is similar to playing a video game. Winning depends on the choices you make and sticking to a well-thought-out plan.
What do a gaming character and an investment portfolio have in common?
Despite being seemingly unrelated, there are resemblances between creating a gaming character and an investment portfolio. Specifically, the thought process and the logic you need to build are both crucial and will determine your chance of success.
In a nutshell, it’s all about the build. It starts with a well-thought-out plan. Building without a plan increases the likelihood of things moving in a direction not initially intended or can even lead to an earlier-than-expected end. By contrast, a proper build minimizes risks or helps you avoid them while simultaneously raising efficiency.
In video games, “build” means a specific arrangement of items, equipment, skills, etc., to best arm a character for the challenges at a certain stage of the game. This build is bespoke because it is based on the specific stats of the character and the player’s own playing style.
Sounds familiar? We can see parallels between how a game player and an investor tackle their tasks. Portfolio construction marries knowledge of both financial market conditions and an investor’s risk profile. From a gamer’s point of view, building and maintaining a portfolio can be done by thinking about the following:
Consider your “playing style”—take note of your risk tolerance, appetite, and objectives. Investors have different perceptions of risk. Some like very little risk, while others welcome or even seek it out (risk appetite). This has to be matched with your capability to handle risks (risk tolerance) and what your investment goal is (objective).
Understanding where you stand in relation to these elements will help you create a risk profile.In video games, the conservative gamer (Player 1) may prefer to hit targets from a distance, whereas the aggressive gamer (Player 2) may prefer to be in the thick of the action.
Choose a character—asset allocation matters. After determining your risk profile, select a portfolio asset allocation that best matches it.Prior studies have suggested that a significant portion of returns are due to a portfolio’s asset allocation.
This step is a balancing act between risk and return. Higher risk means a higher return. Conservative investors have more time deposits compared to aggressive ones who have more stocks. Here, Player 1 has a higher tendency to pick an archer, while Player 2 will go for the swordsman.
Pick your equipment—load up on specific securities. With the allocation set, the investor buys a list of securities (bonds or equities). Now the initial portfolio is constructed. In gaming, Player 1, the archer, goes for the bow and arrows, while Player 2, the sword and shield.
Explore and fulfill mission objectives—scan the market landscape and rebalance your portfolio accordingly. With the objective and portfolio set, you now need to look outward and check economic conditions and financial markets.
Are interest rates high? Is economic growth rising or declining? Are company earnings sustainable? Answers to these questions will paint a backdrop of market conditions that need to be considered in selecting a strategy. It’s like Player 1 and Player 2 are exploring the map to fulfill mission objectives. They face challenges that force them to reevaluate.
Recalibrate player equipment when necessary—work out portfolio allocation and security selection to fit the current market situation. Financial markets and the economy undergo cycles, and your portfolio needs to adapt to these changes. Recalibrating portfolios involves rechecking the portfolio’s asset allocation and securities. Economic booms give you the opportunity to be more aggressive, while recessions require a defensive touch.
Being flexible and not falling in love with portfolio holdings is important. Your financial advisors and portfolio managers, likewise, play a huge role in giving you guidance. Players 1 and 2 need to recalibrate, too, depending on their mission. They can change their equipment to become more effective. This goes on and on until they reach the end of the game and come out triumphant.
Just like with any endeavor, it takes practice to sharpen your expertise, regardless of whether it’s playing a video game or investing. Looking at current market conditions, it may look like the difficulty level in building a portfolio is set at an expert level. In times like these, gamers usually consult with reviews and guides. Investors, likewise, are advised to do the same.
Sounds like a plan? Have a conversation with your investment advisor. It never hurts to have an edge when it comes to investing.
JON EDISON MUNSAYAC leads the Portfolio Solutions Department of Metrobank’s Trust Banking Group which specializes in providing investment-based answers for clients’ portfolio needs. He has a little over 10 years’ worth of experience in trust banking, primarily in markets research, strategy, and investment solutions. He is a storyteller at heart and an avid believer in keeping things simple when possible.
Maximizing returns on your bond portfolio
In times of turbulent markets and uncertainty, bond investors will need to turn to their trade plans to remind them of their goals.
It pays to plan. In times of rising global and local interest rates, a plan will keep you on track towards achieving your goals. Now more than ever, a trade plan will help you maximize your returns or keep you from losing money.
If you are looking to buy bonds, you can start with three questions: Are the funds to be invested intended for hold-to-maturity? Are you after the cash flows from coupons? Or are you aiming to make gains from trading?
These questions will help you to choose which among the wide selection of securities is best suited for your goals—considering the tenor and yield. They will help you determine your investment horizon, or the amount of time you can leave your funds invested before you need the proceeds.
However, if your goal is to take profit on existing holdings, either to reinvest in better yielding bonds or to liquidate positions, then setting target exit and entry levels is a must. Trade plans should have very specific target levels, which give the investor the benefit of estimating their gains.
When to buy, when to sell
They say that timing is everything, and this is especially true for bonds now. Investors would want to buy when yields are high (bond prices are low) and sell when yields are low (bond prices are high).
Forming a trade plan should always be guided by an outlook on interest rates. As a concrete example, major central banks around the world, as well as the Bangko Sentral ng Pilipinas (BSP), are currently looking at hiking rates throughout the year to quash inflation.
With the prospect of higher interest rates on the horizon, any price rally should be taken as an opportunity to take profit, especially in the short- to medium-term bonds, where new and better yielding bonds are likely to be offered.
Keep an eye on bond issuances
For those who are looking to buy peso bonds, it would also be valuable to pay attention to the weekly issuances of government securities by the Bureau of the Treasury (BTr) and to opportunistically participate in these auctions with a target yield.
This should give bond investors a better idea of where virtually “risk-free” peso rates are, which should also be helpful in comparing with higher-yielding corporate bonds. Needless to say, being up-to-date with new corporate bond issuances is also ideal.
When assessing which bonds or tenors offer good value, some traders often evaluate “yield spreads”. In bonds, the yield spread, or simply the “spread”, is the difference between two yields. Take, for example, a five-year peso government bond that yields 6% and a similarly-tenored five-year peso corporate bond that yields 7%. The difference is 1%, expressed as 100 basis points (bps).
On the other hand, if another five-year corporate bond from another issuer yields 7.40%, then the spread between the two corporate bonds is 40 bps. This 7.40% peso corporate bond would also offer a 140-basis point spread over the 6% peso government bond.
Compare with other bonds
Trade plans take into account a bond’s “relative value” and look at the spread that a particular security offers over comparable bonds. Comparable bonds are usually those that have the same risk rating, the same (or closely similar) issuers, across either the same or different tenors. Oftentimes, it is also important to consider the spread over the key benchmark interest rate.
Traders also look into the historical trends in spreads, to see whether a particular bond or tenor is already looking attractive at current levels. If seven-year peso government bonds offered a 200-basis point spread over the key policy rate five years ago, and high inflation now offers 400 bps in spread over the same benchmark, then some may consider this pick-up in yield spreads substantial.
Considering other factors such as the outlook for rates, other tenors, sentiment, etc., some may find this current pick-up in yield spreads a good entry level for a seven-year peso government bond.
Feeling the market
Lastly, market sentiment for risk is another important consideration when crafting trade plans. For example, if the market is not optimistic about the near future, a sell-off in short-term bonds would ensue, and market participants would favor longer-term bonds.
Short-term yields would then go higher, which would not bode well for holders of these short-term bonds. Therefore, anticipating market sentiment when planning where to reinvest bond proceeds should be done in a timely manner. Trade plans may also be updated from time to time, in keeping with the goal of being opportunistic with trades.
Overall, being guided by target entry or exit levels, as well as an assessment of relative valuation, are the most crucial benefits of a trade plan. Having said that, coming up with one could be very tricky in times of rapid increases in rates.
But don’t fret—you can always consult with your investment specialist to ask for timely trade strategies and market outlook. Luckily, Wealth Insights is also here to keep you abreast of the latest developments in the financial markets, top portfolio picks, and the latest trade plans.
PATTY MEMBREBE is a Financial Markets Analyst at Metrobank – Institutional Investors Coverage Division, under the Market Strategy and Advisory Section. She communicates strategies on fixed income, rates, and portfolio solutions for our high-net-worth individual and institutional clients. She holds an AB Economics degree from Ateneo de Manila University and is currently pursuing graduate studies. On her free time, she enjoys watching indie films and watching gigs to support local indie music.
Do you know the types of stocks you are invested in?
Knowing what type of stocks you own can help you come up with an appropriate investment strategy.
Before investing in stocks, you might want to first understand what you are getting yourself into. Classifying stocks is part of the process. Knowing the unique characteristics of stocks can help you make more informed decisions and choose the most suitable investment strategy.
There are more than 200 listed companies in the Philippine Stock Exchange (PSE). In which of these buckets do your stocks fall into?
One way to sort stocks is based on the investment management strategy, distinct characteristics, risk and valuation. They can be classified under growth, defensive, speculative, and cyclical.
There are various ways to classify stocks. Here are four classifications that you may use to manage your portfolio better.
Investors who hold growth stocks generally employ a passive investment strategy which does not require regular monitoring. An example would be Metro Pacific Investments Corporation (MPI), which is into services, products, and infrastructure: power, toll operations, water, healthcare, rail, logistics, and others. Another is International Container Terminal Services, Inc. (ICT), which is into the international container cargo business.
The underlying corporations have superior investment projects which explains the substantial portion of their profits being retained. These stocks are usually undervalued due to asymmetric information.
Just like growth stocks, defensive stocks can be held without much monitoring. Consumer staples and stocks in the utilities sector constitute this category. These are considered defensive as their businesses are more likely to withstand economic downturns, with low business risk, and moderate financial risk. This is because their products or services are necessities at any point in the economic cycle. These stocks provide regular dividends and stable earnings.
Some of these defensive stocks include Manila Electric Company (MER), an electricity distribution company that operates in the cities and municipalities of Bulacan, Cavite, Metro Manila, and Rizal. It also covers certain cities, municipalities, and barangays in the provinces of Batangas, Laguna, Pampanga, and Quezon. Manila Water Company, Inc. (MWC) is another. It provides water treatment, sewerage and sanitation, distribution services, pipe works, and management services to residential, commercial, and industrial customers.
Speculative stocks are for investors who are constantly monitoring their investments given that prices of these stocks are volatile. Sectors which are included in the category are mining and oil, and IT companies with little or unpredictable earnings. These stocks are held for speculating (betting) a significant change in the business that may unlock value in the company like surge in earnings, getting big customers, or part of a merger or acquisition transaction. Due to investors speculating for things to happen which may not be the case, these stocks are usually overvalued. This is an extreme example of high risk investment with high potential return or loss.
Examples of speculative stocks would be Semirara Mining and Power Corporation (SCC), a company that operates in Semirara Island, Caluya, Antique, and Nickel Asia Corporation (NIKL), which is engaged in the mining of all kinds of ore, metals, and minerals as well as power distribution.
Cyclical companies are generally held as part of an active investment strategy. Cyclical stocks have businesses that perform better with a favorable economic environment. Real estate and financial institutions are sectors included in this category. These stocks are heavily influenced by overall market sentiment and general economic activity. Superior returns are expected during economic expansions, and poorer results (compared with defensive stocks) during contraction. That is why volatility is expected in their asset values.
Some examples would be Ayala Land, Inc. (ALI), a real estate company, and Metropolitan Bank & Trust Company (MBT), one of the leading banks in the country.
After knowing the types of stocks, you should carefully evaluate your current or planned portfolio and assess if the stocks you are holding are appropriate to 1) the economic environment – you may want to invest more money in cyclical companies when high economic expansion is expected; 2) your risk appetite – you should remember that holding speculative stocks or some rumored backdoor listings can provide high returns, but also big losses; and 3) your investment horizon – though equities generally entail a longer holding period than other asset classes, growth stocks require even more patience from the investor versus speculative and cyclical stocks which can be tactical, and defensive stocks which pay regular dividends.
ANNA DOMINIQUE CUDIA, CSS, is the Head of Markets Research and Strategy at Metrobank’s Trust Banking Group, spearheading the generation and presentation of financial markets insights to internal and external clients. She used to be with Metrobank’s Investor Relations, where she brought in international awards and took part in various multi-billion peso and dollar capital raising activities. She has a Bachelor of Science in Business Administration degree, cum laude, from the University of the Philippines. She is also a CFA Level I exam passer, a Certified Securities Specialist, and a Global MBA (Finance) candidate at the University of London. She is a naturally curious person and likes to travel here and abroad.
Navigating the world of Investments
Make your money work for you with guidelines that can help you move further along your own investment journey.
It is often said that investing in the stock market is a rich man’s game. And perhaps no place has internalized this statement more than the Philippines.
According to the Philippine Stock Exchange’s latest Stock Market Investor Profile report, the total number of stock market accounts was recorded at 1.23 million last year, a number that, while impressive, is but a tiny fraction of the country’s more than 100-million population. There are a number of reasons why.
First, a portion of our population still lives on a day-to-day basis so investments for them are still a luxury. For those with excess cash, our tendency is to purchase more immediately-felt, luxury goods rather than save and invest for the future.
Second, financial literacy is not part of the general curriculum in most educational institutions. If properly taught in schools, many Filipinos should have a firm grasp on the importance of investments at a young age.
Third, the rise of networking businesses had somehow overshadowed traditional investment vehicles. Traditional investments have suffered as a result, with many people believing them to be “low-yielding” instruments compared to business ventures.
Despite the challenges mentioned, traditional investing remains to be a viable medium to grow one’s nest egg.
Understanding the different asset classes is important when you start investing. It is also important to know some common investment misconceptions.
One misconception is that equity investments are greatly associated with luck and give quick returns. The truth is equity investments are not short-term investments because short-term gains in equities usually overshadow the risk in the near-term.
Another misconception is that Filipinos believe that you need a large amount of money to start investing, when in fact there are collective investment schemes like mutual funds and Unit Investment Trust Funds (UITFs) offered by popular commercial banks that have very low minimum starting amounts.
Investing has also become very convenient with the advent of online platforms offered by financial institutions. One needs only to take a few minutes to set up an account with any of the available online investment platforms or with their bank to start investing for their future.
When you start to invest, there are several things to be considered. The first thing that needs to be established is how much money or savings you will need by the time you retire so that you have a goal to achieve. With that goal in mind, you need to determine how many years you need to save for that amount. An amount needs to be set aside regularly towards that goal.
The best time to start investing for retirement is right now. If you invest later on in life, you run the big risk of not having enough savings to sustain your lifestyle after retirement.
Next, we need to determine what type of investments is needed to reach our goal. If the investor opts for safer investments like only time deposits and bonds then the annual contributions will need to be larger, if they add equities in the portfolio mix then the annual contribution may be less.
In addition, you also need to assess your own personal liquidity situation. Will you be needing your money over the next year as you plan to make a huge purchase? Will you need you money in the next few years? In general, for funds you will need in a year, it should be limited to time deposit. Funds that will be needed in the next three years should be limited to bonds, and any excess cash that will not be needed in the foreseeable future should be invested in either equities or real estate.
The problem with most investors is that they tend to stick to the asset class they are familiar with only. In some cases, most investments are lumped in Time Deposits and Bond only which, as mentioned above, hardly beats inflation. In other cases investments are limited to local currency investments only. A good mix of safe and risky investments will ensure that a portfolio can reach your desired goals.
For new and inexperienced investors, we suggest investing in a healthy mix of collective investment schemes like UITFs or mutual funds for starters. As they get more investment savvy, they can start investing on their own or hire experienced asset managers to run their investment portfolio.
Speak to the experts and continue to learn. Understand in what scenarios each asset class performs well in, who are the major players in that investment market and how do they think, the technical aspects of the investments particularly valuation (whether it’s cheap or expensive). Let the experts manage your personal investments. Hire an asset manager for this purpose as they have the skill, expertise, resources, and infrastructure to make sound investments.
At the end of the day, investing gives us an opportunity to further grow our hard-earned money to prepare us for the future.
LEANDRO ANTONIO “DONDI” SANTILLAN is Senior Vice-President and Head of the Metrobank Trust Banking Group. He sets the overall direction for the trust banking business in terms of profitability, performance, and industry ranking.
This opinion article is part of Metrobank’s Financial Education campaign series.