All the complicated investment strategies are ultimately about seeking a balance between risk and return.
While the goal of investment varies from one case to another, there is no correct answer as to where the point of balance should be.
There are 50 composite stocks in the Hang Seng Index, of which the largest eight companies weigh 55.73 percent in the index.
The index itself is an investment portfolio. The Tracker Fund (02800.HK), the exchange traded fund which tracks the Hang Seng Index, is one of the most actively traded ETFs in the Hong Kong market.
The HSI formula is based on market cap. The performance of big-cap stocks like Tencent (00700.HK), HSBC Holdings (00005.HK) and China Mobile (00941.HK) will have a big influence on the performance of the index.
Smart Beta Investing strategists understand this quite clearly. So they launched ETF products with equal weighted stocks which will adopt the same allocation mode to all stocks regardless of their size.
For example, Tencent weighs 13.13 percent in the HSI, but under the equal weight rule, it will only weigh 2 percent in the ETF portfolio.
Although the HSI is anchored on the giant companies, it has 50 constituent stocks which are frequently reviewed.
From the asset allocation perspective, the Tracker Fund is unlikely to repeat the story of Sequoia. (As I mentioned in my previous column, Sequoia at one point placed as much as 32 percent of the fund’s portfolio in Valeant.)
The point is, to outperform the market, the portfolio should not track the market benchmark. Return is accompanied with risk. To achieve a higher return, investors will have to shoulder higher volatility than that of the overall market.
A study shows that the more diversified portfolio will offer a more stable return, but the return level is highly correlated with the market.
On the other hand, a portfolio with fewer stocks has a better chance of realizing better returns than the market, while the risk to underperform is also higher.
So the bottom line is simple: higher return is accompanied by bigger risks. Everything depends on your appetite.
The fundamental lesson of the Sequoia fiasco (March 29, 2016)
This article appeared in the Hong Kong Economic Journal on March 30.
Translation by Myssie You
[Chinese version 中文版]
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