wealth strategy- unbderstanding risks & portfolio creation

8/7/2019 wealth strategy- unbderstanding risks & portfolio creation

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Wealth Strategy

Understanding basic portfolio

construction and riskSudhir Upadhyay Managing Partner , Equal Partners Wealth AdvisoryPhone: 9158041122

Email: [email protected]


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Important constituents

Vision & Horizon

Returns

Risk Consistency

Tax

Transfer of Wealth


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Vision

Investing for a month, year or years

Defining core objectives

Differentiating between wealth creation &wealth management

Formulating strategies for Wealth Creation as

well as Wealth Management


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Returns

Are explained by

Beta- the exposure one has to the markets. Beta iswhat investors get rewarded for being in the market

Alpha- the excess returns one generates over andabove the normal returns obtained by just being in

the markets


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Beta & Alpha - Why

Beta Why is it needed? being invested in the market and going with the flow

ensures you only face as much risk as the market in general faces and get asmuch return

Passive strategy

Needs less frequent monitoring

Addresses core needs- you design meeting your longer term financial objectivesby relying on the normal & general forecasts for the markets. Therebyavoiding undue risks to the portfolio. Beta returns in general are more forecastable than alpha returns

Alpha Why is it needed?- Wealth creation largely depends on Alpha generation.

Disproportionate risk is rewarded by disproportionate returns

Once core objectives are secured through financial planning, attempts can bemade to generate alpha by cordoning such investments in a way that the lossesfrom these do not affect the core objectives


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Investment Styles

Core & Satellite approach

Core portfolio focuses on meeting the core financial objectives.

Relies on asset allocation to generate sufficient returns in asmuch risk averse manner as possible

Case : A client focusing on building a retirement corpus. Has 10 years in hand and wants a steady

appreciation over his accumulated savings. The client can face shorter term volatility to participate inassets which grow at double digit rates in future. However the client is not willing to lose principal orface a negative return on the overall portfolio.

Satellite investing is driven by aspiration rather than need

Satellite portfolios will have higher investment expenses andrisks while compared to the core portfolios

Case: A client wishing to invest in a portfolio has the capability to provide gains in excess of 100% in ayear, and understands that such investments can be highly volatile and can result in substantial capitalloss if the investing premise does not turn true. The investment is one single stock about with highconviction


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Core Portfolio- driving logic

Core Portfolios are constructed using modern portfolio theory as

a guiding principle

Modern Portfolio theory derives heavy contributions from Dr

Harry M Markowitz , who won a Nobel Prize in 1990 for his

efforts.

Core Portfolios tend to follow an efficient frontier

Efficient Frontier- focuses on substituting an investment by

another efficient investment if such investment generates a

higher return to previous investment but maintains the same risk

levels as the previous investment.

Core portfolios run for longer periods of time where diverse

investments help cancel each others risk and produce more

steady returns over a period of time


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Efficient Frontier

Efficient Frontier: Balancing Risk and Return In 1990 Dr. Harry M. Markowitz won the Nobel Prize in Economics for his work in developing Modern

Portfolio Theory. Dr. Markowitz showed that the most effective portfolios are those that lie along theEfficient Frontiera series of points that models the range of possible portfolios, each representing the

combination of investments that has the maximum rate of return for every given level of risk, or theminimum risk for every level of return.

Therefore, the goal of a prudent, conservative investor is to develop a portfolio that lies as close aspossible to the efficient frontier. Portfolios that lie below the efficient frontier are getting too low a returnfor the risk being taken, while portfolios that attempt to lie above the efficient frontier are generallytaking more risk than appropriate.


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Satellite Portfolio- driving logic

Satellite Portfolio's tend to focus on gaining from market

inefficiency over shorter periods of time

Market inefficiency over shorter periods of time can emerge from

lack of knowledge, execution skills, superior securities selection

etc.

Satellite Portfolio managers are strongly convinced about their

ideas and investment logic and hence concentrate their holdings

to gain from the price movement in this short period

Satellite Portfolios are often tactical plays


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PortfolioReturns Explained

Asset Allocation primarilydetermines how a portfolio willbehaves over the longer term.

Core Portfolios follow this principle

Security Selection andMarketTiming can also add to thereturns of the portfolio, but it ismore difficult to achieve thanachieving returns consistently

through asset allocation

Satellite Portfolios focus ongenerating the alpha byconsidering the above two factors


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Risks- Systemic & Asystemic

Systemic Risks- are those risks which affect all in the system the same

way.

E.g., if the index moves from 20000 to 10000 all invested in the index

lose the same amount, and if the index moves from 10000 to 20000 all

invested gain back the lost amount. Asystemic Risk- are those risks which are specific to a particular

investment and needed not be faced by the market in general.

For e.g., a company can be highly leveraged and face financial

problems in tightening liquidity.

All investments can face systemic and some investments can face both

systemic & asystemic risk at the same time.

While an investment can recoup the loss due to systemic risk soon as

the market bounces back, those facing asystemic risk may not react to

the markets upward move.


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Risks in perspective ofCore &

Satellite Portfolio Core Portfolios are constructed in a way so as to have minimum impact

from asystemic risks.

Diversification helps in maintaining low asystemic risk

Satellite Portfolios being concentrated in nature will highly be prone toasystemic risks along with systemic risk like any other investment

Satellite Portfolios will therefore look to seek rewards in greaterproportions for assuming both types of risk as compared to Core

Portfolios which primarily assume systemic risks


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HowCore Portfolios work

Oversimplifying - growth stocks do well during the early portion of the growth phase of the business cycle. Commodities then tend to outperform as the business cycle matures and commodity prices zoom up due to

inflation. Money market funds tend to outperform as a recession starts to kick in.

Bonds do well as inflation evaporates and becomes disinflation or even a little deflation. This model is not guaranteed to work and every business cycle has its own quirky characteristics, but does help to

explain some of the investment and speculative behavior we see in the markets.

Core Portfolios are intended to run for longer number of years and hence diversify to adequately capturegrowth from all cycles through various asset classes & at the same time not allocate substantially in one assetclass to avoid excessive losses in an adverse cycle

Satellite portfolios on the other hand thrive from their abilities to predict such cycles and therefore allocatedisproportionate assets in such asset classes which are deemed to be favorable


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Sector Rotation


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FewLearning's

THE rich don't stay rich for long.

Only one in five of the wealthiest people is able to remain within the elite top 400 for two decades, said astudy by investment bank JP Morgan. The study was based on an analysis of the Forbes magazine rich list whichhas ranked the world's wealthiest over the past 20 years.

The downfall of the rich is caused by erratic stock markets, heavy taxes and the irresistible urge to 'shoptill you drop', reported The Times of London recently.

More than 200 people have 'destroyed' their wealth through poor investment decisions. They include Yoko Onoand Estee Lauder, who founded the successful cosmetics business. According to JP Morgan, all the originalsuper-rich would have remained in the top echelon had their investments or assets grown at the samerate as the stock market - the benchmark for the study.

But many mistakenly stuck to investments or assets that helped to make them their initial fortunes.

'Diversifying assets is the key way to stay wealthy but it is the method most difficult to swallow as it canbe an emotionally difficult thing to do

The bank has found that many fortunes do not survive beyond the third generation as the offspring of the wealthygo on huge spending sprees. It cited Paris Hilton as an example. She is renowned for her large clothing bills which

are paid for from the Hilton hotel family's fortune.

Only 50 people have maintained their position on the list.

They include WarrenBuffett, the legendary stock market investor who is the world's second richest man; WilliamClay Ford, of the Ford cars family; Roy Disney of the cartoon and theme park family and Philip Knight, the founderof sports shoes maker Nike.


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Thank You

Please email for further queries :[email protected]

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