Key points:

- Most investors do not start with S$10,000, but most examples of portfolios start with at least S$10,000
- Key feature 1 is global diversification, not just geographically, but across assets as well
- Key feature 2 is fund selection, and the Fundsupermart recommended list has helped identify quality funds
- By first identifying target allocation, and carefully selecting funds, I show how an investor can create a globally diversified portfolio with less than S$5,000
- Part 1 covers diversification and fund selection, portfolio maintenance is covered in part 2

Most discussions about portfolios assume an investor starts with S$10,000. And that’s a problem, because most investors start investing because they want to have S$10k lying around, and not because they have S$10k lying around.

That said, you should only start investing with money you don’t need for day-to-day living expenses, including medical coverage, hospitalisation coverage and other things that help insulate you from the rougher realities of life. And, Singapore being what it is, you’re unlikely to have 10k left lying around after all that. I certainly don’t.

Speaking from personal experience, I started with little more than S$4000, which meant I couldn’t even mirror the Fundsupermart recommended portfolios, since my starting capital wasn’t enough to allocate to the 5-10 fund holdings of each portfolio. So what’s an investor of limited means to do?

My proposal to you, gentle reader with limited resources, is to create a simple portfolio, stripped down to its most crucial features. So what critical features should such a portfolio (or any portfolio for that matter) possess?

There are three key features that should be present in any portfolio. These features aren’t just there because they sound cool (they don’t), or because everyone is doing it (not everyone does): these are key features that contribute to the long-term outperformance of any portfolio. The three features are 1) Diversification, 2) Fund Selection and 3) Portfolio Maintenance

We’ll cover two features in part 1 of this article and finish with the third feature in part 2.

Key Feature #1: Diversify Twice

The first principle is proper diversification at two levels.

The first is geographical, where the goal is to gain exposure to a global portfolio of equities. The importance of being globally diversified is to reduce the risk that a single country’s slowdown decimates your portfolio returns. But that’s not enough, because we still need an asset that is weakly correlated with equities.

For readers unfamiliar with the concept of correlation, very simplistically, correlation is a measure of how two variables move in relation to each other. Correlation varies from +1 (perfect positive correlation) to 0 (perfectly random) to -1 (perfect negative correlation). A correlation closer to +1 implies positive correlation; for example, weight is positively correlated with mass – as one increases, so does the other. A correlation closer to -1 implies negative correlation; for example, the time taken to reach a destination and the speed of travel – as speed increases, time needed to reach a destination decreases.

Weak correlation refers to a correlation nearer to 0, and implies the relationship between two variables is weak, i.e. the fluctuations of one variable have little impact on the other. There is no single value that defines what ‘weak correlation’ is, so for the purpose of this article, we will take a broad guideline of a correlation between +0.2 to -0.2 to denote weak correlation.

We want a weakly-correlated asset in relation to equities, because equity return is volatile – positive one year, negative the next – and during times when equity return is negative, a weakly-correlated asset can help offset the negative performance of equities.

Geographical diversification alone won’t do the job, as equity funds of various regions and countries are not weakly correlated with one another (as shown in Table 1), hence the need for diversification across assets.

Once upon a time, in my youthful folly, I would have happily dismissed bond funds for old people facing retirement, with ignorance-born bliss. That is, until 2008 rolled along. One financial crisis and many grey hairs later, I learned the importance of bond funds in a portfolio, in other words, holding two assets that rise or fall independently of one another. Table 2 illustrates this relationship between bond funds and equity funds – generally weak correlation.

From Table 2, we can see the performance of bond funds are generally weakly correlated with equities. The exception is the FSM EM Bond index, which has a correlation slightly higher than other FSM Bond indices.

Having identified diversification as one of the key features of our simple portfolio, we’ll move on to our next feature – fund selection.

Key Feature #2: Setting Allocations and Selecting Funds

First, decide on an asset allocation for the portfolio. Depending on your risk appetite, you can adjust accordingly to suit your taste, but for the sake of this article, we’ll choose a balanced allocation of 50:50 between bonds and equity. Our reason for doing is so is to give a good mix of bonds and equity holdings, as well as for ease of allocation, as the minimum investment amount for most funds is S$1,000.

With our asset allocation set, we now move onto the question of fund selection.

With S$4,000 we can choose four funds to make up the portfolio: two equity funds, and two bond funds. So how do we select four funds for our portfolio? I offer two suggestions.

The first solution, and the solution of minimal effort, leads us to the 2011 FSM Recommended Funds; choose two from core regional equity funds, and two from bond funds. The team at Fundsupermart has performed the quantitative analysis for you, and the funds on the list have, over the long-term, been able to outperform their respective benchmarks. These funds tend to have low expense ratios, and good track records, as per our Recommended fund methodology.

The second solution, which requires some reading up on your part, takes this a step further – look for funds that have repeatedly emerged in our Recommended fund lists. This identifies consistent outperformers in the Recommended fund list, and gives you a list of funds that have displayed consistency and longevity in the asset management profession.

For the sake of clarity, I’ll walk you through an example of how I would select four funds for a portfolio.

An Example

Here is an example of how I’d go about constructing a globally-diversified portfolio of four funds.

Disclaimer: the following process is for illustrative purposes only, and should not be the sole basis of any investment decision made. Your risk appetites and investment objectives are your own and this portfolio may not adequately address your unique circumstances.

First up, using our research team’s recent update to their outlook on the markets, I’m choosing two regional equity markets – the US, and Emerging Markets. I pick the US, because it serves as a proxy as the world’s developed markets, and it’s more attractive than either Japan or Europe. I pick Emerging markets, because it encompasses Asia ex-Japan, and hence provides more investible opportunities for fund managers to invest in.

Next, for bonds, I’m going with exposure to global bonds for stability and diversification, and high yield bonds for its higher return within the fixed income space. Where possible, I’m seeking SGD-hedged returns, or a bond fund managed from an SGD perspective. This is to guard against sudden SGD appreciation eating away at my returns.

Starting with our recommended fund report, I compile the current recommended funds for the four sectors – US equity, Emerging markets, Global bonds, and High-Yield Bonds, and run through the articles that discuss the performance of each fund, as shown in Table 3.

Running through each of the funds, and reading through the various articles discussing the funds, I come to a decision on which funds to select. I document my choices and reasoning, along with any notes, as illustrated in Table 4.

Documenting this step is important, since I will have to regularly review each fund in my portfolio, and see if it still meets my investment goals, or whether the fund’s investment mandate or management has changed.

Once I have my four funds, I can then invest S$1,000 into each of them, and voila – a simple, globally diversified portfolio worth S$4,000.

Time for a break

Well done if you’ve read this far. Don’t worry, we’re nearly done. Much of the heavy lifting has already been done, and we’ve set a good foundation for this simple portfolio to grow into something bigger.

There’s one more step to go, which is maintenance, otherwise known as rebalancing. It’s a good time to take a break before we forge on. See you next article!

If you have any comments, questions or complaints about the article, feel free to drop a feedback post in our forum, or email me: nicholastay@fundsupermart.com