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Diversifying personal investment portfolio

Piggy’s Trading & Investing Tips:Batanai Matsika

IN his book, The Intelligent Investor, Benjamin Graham describes an aggressive investor as an enterprising security buyer who desires and expects to attain better overall results than his defensive or passive companion.

According to Graham, it is important that the enterprising investor starts with a clear conception as to which courses of action offer reasonable chances of success and this may include the following;

Trading in the market
This means buying stocks when the market has been advancing and selling them after it has moved downwards.

Short-term selectivity
This means buying stocks of companies which are reporting or expected to report increased earnings, or for which some other favourable development is anticipated.

Long-term selectivity
The emphasis here will be on an excellent record of past growth, which is considered likely to continue in the future. In some cases, the “investor” may also choose companies, which have not yet shown impressive results but are expected to establish a high earning power later.

According to Graham, stock trading is not an operation, “which on thorough analysis” offers safety of principal and a satisfactory return. In his endeavour to select the most promising stocks, the investor faces obstacles like human fallibility and competition. He may be wrong in his estimate of the future while the current market price may already fully reflect what he is anticipating. Overall, there is a possibility of outright errors. Graham then comes up with a conclusion that: To enjoy a reasonable chance for continued better than expected results, the investor must follow policies that are (i) inherently sound and promising and (ii) are not popular on the market.

Piggy believes that the answer lies in developing a sound investment policy and strategy over time. The stock market has various possibilities of achieving better than expected results. There is a huge list of securities from, which a fair number can be identified as undervalued by logical and reasonably dependable standards. Here are some of Warren Buffet’s investment principles that one can build on:

l Invest in what you know;

l Before buying a stock, list the criteria;

l Be aggressive during tough times

l Do not worry about the day to day market movements; and

l Buy Buffett’s stocks.

Looking at the Zimbabwean context, an interesting story when it comes to investing as a retail player on the Zimbabwe Stock Exchange (ZSE) relates to the case-study of Roy Turner. He passed away early this year at the age 86 and was an astute investor on the local market who held a significant portfolio on the ZSE given that he still appears on many top 20 shareholder lists for ZSE companies.

Some of his holdings are in Mashonaland Holdings, Masimba Holdings, Proplastics, Falgold and African Sun. We note that sometime in September 2005, SCAIFLOW Investments (Turner’s company) became one of the leading investment vehicles on the ZSE, spreading its interests across 24 listed companies out of the 80 counters.

While Turner was very conservative, never married and used a bicycle as his mode of transport, a lot of ideas can be learnt from him regarding investing on the stock market. An important lesson that can be taken away is on how to diversify a personal investment portfolio.

Diversification is one of the most important aspects when it comes minimising risk within an investment portfolio. The rationale is that a portfolio constructed of different kinds of investments poses a lower risk than any individual investment within the portfolio. Diversification therefore helps to mitigate the unpredictability and volatility of markets for investors. By increasing the number of securities in a portfolio, one can achieve higher Sharpe ratios.

Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks yields the most cost-effective level of risk reduction. Investing in more securities yields further diversification benefits, albeit at a smaller rate. The following are some of seven ways retail investors can diversify their investment portfolios:

Diversification across asset classes

Investors should always consider their investment mix and look to diversify across different asset classes such as property (REITs), stocks, bonds, cash, mutual funds and other alternative investments. The asset mix can also be structured in line with investor needs and objectives. For example, if an individual is looking to retire soon or if they may need cash, bonds and short-term investments may be appropriate.

Diversification within each asset class
Investors must always be wary of overconcentration in a single stock or asset. It may not be advisable to have a single stock constituting more than 5% of your stock portfolio.
Sector diversification

Securities within the portfolio should vary by industry. A key question that retail investors ask is how many stocks they should buy to reduce the risk of their portfolio. According to portfolio theory, after 10-12 stocks, you will move towards optimal diversification. However, the 12 need to be diversified across sectors or industries. For example, an investor can invest in various sectors such as food producers, retail, telecommunication, forestry and paper, life assurance, technology, pharmaceuticals and packaging.

Diversifying by market capitalisation

Another way is to diversify stock holdings by investing in small, mid, and large caps companies.

Diversifying the styles

Investing in different themes such as growth and value could also bring a balance within a portfolio.

Diversifying through management

The Fund of Funds concept is based on the need to diversify by bringing in different management strategies within a portfolio. In a similar manner, retail investors can also allocate some funds to external managers. Examples include managed portfolios that are provided by several on-line share trading companies.

Geographical diversification

An economic downturn in Zimbabwe may not affect Kenya’s economy in the same way; therefore, having investments on the Nairobi Stock Exchange gives an investor a small cushion of protection against losses due to a downturn in Zimbabwe. In the same vein, ETFs (Exchange Traded Funds) such as db x-trackers (USA, World and FTSE) provide investors access to foreign indices which in turn provides a perfect avenue for diversification. We welcome initiative by the ZSE to introduce low cost ETFs on Zimbabwean capital markets.

Overall, it should be highlighted that most non-institutional investors have a limited investment budget and may find it difficult to create an adequately diversified portfolio. Low cost ETFs provide a platform for investors to gain exposure in global indices, commodities and track local indices. In conclusion, the investment mix or asset allocation that is chosen should always be aligned to one’s investment time frame, financial needs and comfort with volatility.

Matsika is the head of research at Morgan & Co, and founder of piggybankadvisor.com. — batanai@morganzim.com/ batanai@piggybankadvisor.com or mobile: +263 78 358 4745

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