An Important Distinction Javier Estrada IESE Saving Investing - - PDF document

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An Important Distinction Javier Estrada IESE Saving Investing - - PDF document

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Winning Investment Strategies Asset Classes Javier Estrada Winter, 2014 1. Classification A simple categorization 2. Relevant Aspects Role in the portfolio Characteristics Pros & cons for individual investors An Important

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  • 1. Classification
  • A simple categorization
  • 2. Relevant Aspects
  • Role in the portfolio
  • Characteristics
  • Pros & cons for individual investors

Winning Investment Strategies

Asset Classes

Javier Estrada Winter, 2014

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

An Important Distinction

Speculating Investing

To make a bet on an asset’s value

Short term To enhance an asset’s value Long term

Saving

To preserve an asset’s value Short term

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

The Investment Process

Asset allocation Security selection Market timing

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

A Simple Categorization

Stocks Bonds

Alternatives (Others)

These proportions determine most of the portfolio’s return

Go

Upside Protection Diversification

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

A Simple Categorization

Companies Regions Countries Sectors Sizes Styles Governments Companies … Commodities Real Estate Private equity Art …

Stocks Bonds

Alternatives (Others)

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives (Others)

A general comment

(More often than not ignored)

  • Do not use them for speculation
  • A directional bet on prices
  • Use them for their diversification benefits
  • Low correlation to stocks and bonds

Go

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives (Others)

Go

Commodities

(Metals, energy, agriculture, …)

  • Prices are very volatile
  • Hence very difficult to forecast
  • But their correlations to stocks/bonds are ‘low’
  • Hence they are good portfolio diversifiers

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives (Others)

Go

Real Estate

Disadvantages for investment purposes

  • Low transparency
  • Heterogeneous/negotiable/discontinuous price
  • Much lower liquidity than stocks and bonds
  • Very high transaction costs
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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – Return

The return of a plain‐vanilla bond is trivial to estimate

  • The market price and future CFs are known
  • The IRR follows straightforwardly

(Actually quoted together with the price)

  • The IRR is the annualized return to maturity

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – Risk

Go

Avoid a very common mistake

Bonds, even the safest ones, are risky

  • Capital losses are possible if the bond is not

held until its expiration

  • Even then, only the nominal return is locked

(except in inflation‐protected bonds)

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – Credit/Default Risk

AAA AA A BBB BB B CCC CC C

Critical variable: Ratings

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – Credit/Default Risk

Ratings tend to be reliable

  • When?
  • Plain‐vanilla bonds / In the medium to long term
  • When not?
  • Structured products / In the short term
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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – Other Types of Risk

Default risk is critical, but also keep in mind

  • Market risk (May have to sell before maturity?)
  • Liquidity risk (Easy to sell?)
  • Reinvestment risk (Use of CFs?)
  • Bond funds
  • Do not guarantee CFs or an IRR
  • Keep an eye on the average rating and maturity

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – Risk & Return

Plain‐vanilla bonds

A very simple financial asset The nominal return is known beforehand The risk is largely given by the rating

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Companies

Shares in individual companies

Disadvantages for individual investors

  • Broad diversification is very costly
  • Valuation is very time consuming
  • DCF models are tricky to implement
  • Multiples are deceiving
  • Focus on diversified groups of companies
  • Sectors, countries, regions, sizes, styles

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Regions

This list is far from exhaustive

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Countries

This list is far from exhaustive

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Sectors

This list is far from exhaustive

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Size & Style

Size Style

Large cap Mid cap Small cap Market cap Growth Blend/Core Value Multiples Do not worry about precise definitions Rely on the name/classification of the fund

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stock – Size & Style

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Size & Style

Higher risk, higher return Higher risk, higher return

All 9 boxes are investable

Go Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Size & Style

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

In Short

  • Considering 3 broad asset classes (stocks, bonds,

and alternatives) is enough for individual investors

  • Alternatives (Others)
  • Do not use them for speculation (bets on future prices)
  • Use them for their diversification benefits
  • Keep in mind the negative characteristics of real estate

for investment purposes (and remember REITs)

  • Bonds
  • Essential in most portfolios
  • Provide a certain return (if held until maturity and there

is no default)

  • Ratings are an essential tool to evaluate the default risk
  • f plain‐vanilla bonds in the medium/long term

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

In Short

  • Considering 3 broad asset classes … (Cont.)
  • Stocks
  • Essential in most portfolios
  • Focus on diversified groups of stocks (regions, countries,

sectors, sizes, and styles) rather than on individual companies

  • All these groups of stocks are investable through a wide

variety of financial products (MFs, IFs, ETFs)

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Appendix

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

The Relevance of Asset Allocation

Back (*) Brinson, Singer, and Beebower, "Determinants of Portfolio Performance II: An Update."

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives – Art

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives

Back Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives – Commodities

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives – Commodities

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives – Commodities

Back

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives – Real Estate

Source: Global Property Guide

Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Alternatives – Real Estate (REITs)

Back

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Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Bonds – 10‐Year Maturity

Back Javier Estrada IESE Business School Barcelona Spain WININV Winter, 2014

Stocks – Size & Style

Back