Investors love to ask whether is it possible to create a hands-off portfolio so all they need to do would be to watch the money roll in without making any trades in the foreseeable future.
My answer to such a question is, generally speaking, “No.”
Markets are always changing, and the future recession is likely to be very different from one that is triggered by a global pandemic. The price of obtaining the equity risk premium is eternal vigilance, and we should always be ready to beat a hasty retreat if we cannot stomach losses in our portfolio.
Nevertheless, I think that it is still valuable to make a brave attempt to create a hands-off portfolio. Students can bear a fraction of the market-risk in SGX to extract reasonable returns even if these risks are non-zero.
We can build a faux hand-off portfolio keeping with the following conditions in mind:
Every component must yield more than 2.8%
I chose 2.8% because this is currently attainable by putting your money in a DBS Multiplier account and gaming it to the point where you can earn the highest interest. If you take on market risk, this should be the minimum yield that you can tolerate in your portfolio.
We can use only individual stocks or bond and not ETFs
To make this more interesting, the investor cannot invest in an ETF because he will incur management fees.
The risk should not exceed 2/3 of the market risk
For the portfolio to function as hands-off as reasonably possible, the risk must be significantly below that of the STI ETF. We will budget 2/3rd or 66% of the semivariance of the STI ETF to limit our downside risk. Upside risk is, of course, welcome.
The portfolio should still have a chance to do better than the STI ETF
Given the effort we put in, we can attain a higher return than the STI ETF.
Here are the steps to build a faux-hands-off portfolio:
#1 – We start with the Astrea V bond.
The Astrea V bond has a coupon of 3.85%, at an entry price of $1.035 the bond has a yield to maturity of over 3% which meets our objective of yielding more than 2.8%. Unfortunately, I can’t backtest the retail bond due to the lack of data Yahoo Finance, but I can proxy a bond position with the ABF Bond Fund (SGX:A35). The performance from 1 January 2019 to 1 July 2020 is as follows:
Astrea V meets the objective of our design specifications with returns exceeding the STI index over the past year. We also find the semivariance below the threshold semivariance of 11.2% (66% that of the STI ETF).
We still want to do better because bonds will not provide decent returns if the recovery stretches further, so we can sacrifice some amount of risk to push our returns higher.
#2 – We add Netlink Trust (SGX:CJLU)
Netlink Trust (SGX:CJLU) has been a favourite amongst retail investors yielding around 5% at the time of writing. It has also done well during the COVID-19 crisis. The underlying business, use of fibre optics cables, is uncontroversial and meets the criteria of a hands-off portfolio.
Let’s observe what happens when we add Netlink Trust position of equal size to the portfolio.
With Netlink Trust, we can boost returns to about 15% with a small increase in semivariance which is a good trade-off as we can participate in equity returns and not be limited to bond returns when markets recover from COVID-19.
We can add one more counter as we still sacrifice some semivariance to squeeze more returns from our portfolio
#3 – Add Keppel DC REIT (SGX:AJBU)
We add Keppel DC REIT (SGX:AJBU) as it has the lowest Beta amongst all the REIT counters. It moves the least in response to movements in the STI index.
Keppel DC REIT would also make a powerful addition to the portfolio as Data centres are immune to the COVID-19 pandemic. Of course, Keppel DC REIT has been well-received by the investing public and currently yields barely 3%. Data Centres are also almost as powerfully hands-off as fibre optic networks. Let’s see what happens, when Keppel DC REIT gets added to the mix.
We can boost returns even further when we add Keppel DC into the mix, but we have run out of semivariance to buy higher returns.
#4 – Adjust the mix among three counters to optimise the risk-return ratio
At this stage, we know that we can build an almost hands-off portfolio with Astrea V, Netlink Trust and Keppel DC REIT. An equal-weighted mix would yield about 3.6-3.7%, which would be higher than most bank deposit accounts.
With the help of a computer algorithm, we can take an additional step to optimise our risk and bring it down further. This computer algorithm would generate random portfolios consisting of different weights of the three individual counters and find one that optimises towards one combination that produces the highest returns relative to the risk of the portfolio.
From the output, we can do better by reducing our exposure to Netlink Trust to about 5%, raising the Keppel DC REIT allocation to 25% and putting about 70% into the Astra V Bond.
While we did not succeed in building a hands-off portfolio, this combination of stock counters can be incredibly useful to a beginning investor. It has a yield that is higher than most banking deposit accounts even if you can game the bank deposit accounts to get the highest possible returns. The risk is lower than two-thirds of the rest of the STI, and it has also held up well during the pandemic season so is expected to do well if a second crash happens in the stock markets. Buying the portfolio is cheap given that it only comprises three counters.
The biggest weakness of the portfolio is that it is not diversified, meaning that you are subject to the idiosyncratic risk of owning fibres and data centres. The backtest period of about 18 months usually is too short to conclude anything about the portfolio. I am also unable to stretch the backtest further as Netlink Trust is a new entrant to the stock exchange.
The best use of this combination of three defensive counters is a temporary placeholder to park your cash after a recent exit. Students of Early Retirement Masterclass have been eager to know what will happen to their proceeds when they exit their positions in Accordia Golf Trust.
If you enjoyed reading this article, you might as well like to read about building an optimal portfolio for all market states.