system investment strategy through market turbulence

Systematic Investment Strategy Through Market

Turbulence

By : Peter LimCFP, RFP, CFA Level 2 Candidate

Topic Contents:• Learning about History• Quiz : Guessing the market’s direction• What we can learn from the past?• Systematic Investment Strategy:

– Why we should invest systematically?– Dollar Cost Averaging (DCA)– Value Averaging (VA)– Dynamic Asset Allocation (DAA)– Exercise, Advantages and Disadvantages of various

methods.

• Conclusion

Source: Frank Armstrong’s 21st Century Investments

Equity Fund : Historical Charts

Source: Quarter 4, 2007 Quarterly Fund Review of Public Mutual

Equity Fund : Historical Returns

Source: Quarter 4, 2007 Quarterly Fund Review of Public Mutual

Annual Return of PSF

-60.00%

-40.00%

-20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

Source: Frank Armstrong’s 21st Century Investments

Quiz : Guess the market

• There’s 10 KLCI charts, all ranges from 1st Jan to 31st Dec on the same year.

• There’s 5 Years which is higher, and 5 which is lower.

• Given is the 1st half of the year.

• Guess the following half of the year (whether 31st Dec is higher or lower than 30th June)

Question 1

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 1 :

Will Market be

higher 46.7% ?

Question 2

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 2 :

Will Market be

higher -14.91% ?

Question 3

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 3 :

Will Market be

higher -0.79% ?

Question 4

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 4 :

Will Market be

higher 24.67% ?

Question 5

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 5 :

Will Market be

higher 2.23% ?

Question 6

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 6 :

Will Market be

higher 13.96% ?

Question 7

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 7 :

Will Market be

higher -12.45% ?

Question 8

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 8 :

Will Market be

higher -20.34% ?

Question 9

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 9 :

Will Market be

higher -0.06% ?

Question 10

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 10 :

Will Market be

higher -11.05% ?

Question 1 : 1981, Lower to 3.39%

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 2 : 1984, Lower to -25.77%

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Question 3 : 1986, Higher to 14.87%

-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%


-50.00%

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

Quotes from Warren Buffett

• ”We make no attempt to predict how security markets will behave”

• “Successfully forecasting short term stock market stock price movement is something we think neither we nor anyone else can do”


• “We believe that short term forecasts of stock or bond prices are useless. The forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”


• Even Now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

• Forecasting short term price movement is no difference with gambling.

• Investing doesn’t have to be that way.

Imagine you own a casino table:

• Odds for Casino Owner (in a round) : 52%

• Odds for Gambler (in a round) : 48%

• In Short term, either the Owner or Gambler might win (by a lot, too)

• In Long term, it’s the odds that counts.

• The best way to win in Casino, is to own it.

• Better, own it for long term (so that odds is on your side).

• Forecasting the short term direction of the market is a gambler’s game. It’s much better to own the casino (and banks, utilities, food companies… etc) instead.

• Instead of looking for one night stand, I prefer to look for life long partner.

What can we learn from the past?

• Money flows into most funds after good performance, and goes out when bad performance follows.

Humans Are EMOTIONAL !

Systematic Investment Strategy

• What is needed (for most people), is a systematic way of investing, which remove “Emotions” out of investing.

• A good “system” is the one that “force” investors to buy (more) when prices are low.

• DCA , VA and DAA are examples of systematic Investment Strategy.

Dollar Cost Averaging (DCA)

• An easy to implement strategy that combines – a fixed regular investment amount, with – a lower cost acquisition of units than constant

units strategy.

Average ?

Month Invested Amount

Unit

Price

1 $ 100 $ 1.00

2 $ 100 $ 0.50

Average ?

1. What is the Average Cost Per Unit ?(during the 2 months).

Average Cost < Average Price

Month Invested Amount

Unit

Price

Units Bought

1 $ 100 $ 1.00 100

2 $ 100 $ 0.50 200

Total $ 200 300

Average Price = $ 0.75 per unit,

Average Cost = $ 0.67 per unit only !

More vs Less

Month Unit

Price

Units Bought

1 $ 1.00 100

2 $ 0.50 200

Total 300

Month Unit

Price

Units Bought

1 $ 0.80 125

2 $ 0.70 143

Total 268

Fund A-ggresive Fund B-oring

a) Both Funds are invested RM 100 Monthly

b) Both Funds have the same average price per unit (RM 0.75)

c) Fund A is more “Aggressive”, and Fund B is more “Stable”

DCA - Application

• Best applied over 3 years or more to take advantage of the market’s fluctuation.

• Use Funds that fluctuates a lot for maximum advantage

– PEF, PFES, PITTIKAL, PFEDF, PDSF

DCA - Summary

• It is simple to implement as the amount to invest every month is fixed.

• Encourage a person to save regularly.

• However, it does not have an “exit” point to sell.

Start as soon as possible

Value Averaging (VA)

• Value Averaging is a formula strategy that

– is more flexible and

– has a lower average per-unit purchase price (and usually a higher rate of return) than dollar cost averaging.

Value Averaging (VA) cont.

• Instead of a “fixed dollar” rule as with DCA, the rule under VA is to

make the value of each of your unit holdings

go up by $ 100 (or some other amount) each month.

VA Average Cost < DCA Average Cost

Month Unit

Price

Total Value

# Units To Own

Units Obtained

Amount Invested

1 $ 1.00 $ 100 100 100 $ 100

2 $ 0.50 $ 200 400 300 $ 150

Total 400 $ 250

DCA Average Cost = $ 0.67 per unit,

VA Average Cost = $ 0.625 per unit only !

VA Summary

• By focusing on predetermined value goal that increases over time, you take the DCA philosophy of “buy more cheap units” a step further.

• Returns are generally higher, and risk are generally lower (because you’re buying more when prices are low, and possibly sell when prices are high).

• Features of VA makes it more complicated, and tedious to monitor.

Dynamic Asset Allocation (DAA)

• An investment strategy, allocating our investments into various asset classes. Personally, I use Equity Fund and Bond Fund.

• Allocation to Equity Fund will be more when market is “undervalued”, with the balanced into Bond Fund, and vice versa.

• Switching is done periodically.

Ideas behind DAA

Market’s Valuation Equity Fund

Bond Fund

Over Valued 0% 100%

Slightly overvalued 25% 75%

Fairly Valued 50% 50%

Slightly undervalued 75% 25%

Under Valued 100% 0%

Benefits of DAA

• It’s to cater for “big” Lump Sum investment.

• Instead of switching funds, we can also “re-allocate” funds by doing topup to the Asset Class that the portfolio recommends.

• Sell Winners, Buy losers(In other words, you’re selling High and, buying Low)

• Lower Risk, Higher Return

Application of DAA

3 months ago (market is

fairly valued)

Fixed I ncome Equity

Today (market is

slightly overvalued)

Fixed I ncome Equity Equity to Bond

Exercise

• Fill up the blanks on various Systematic methods of Investing.

• While doing it, try to think of the advantages/ disadvantages of each methods.

Constant Unit Purchase (Fixed # of Units Obtained)

Constant Unit Purchase

Month Unit PriceAmount Invested

Units Obtained

1 RM 1.00 RM 1,000.00 1000

2 RM 0.60 RM 600.00 1000

3 RM 1.40 RM 1,400.00 1000

Total RM 3,000.00 3000

Average cost per unit RM 1.0000

Dollar Cost Averaging (Fixed Amount Invested)

Dollar Cost Averaging

Month Unit PriceAmount Invested

Units Obtained

1 RM 1.00 RM 1,000.00 1000.00

2 RM 0.60 RM 1,000.00 1666.67

3 RM 1.40 RM 1,000.00 714.29

Total RM 3,000.00 3380.96

Average cost per unit RM 0.8873

Value Averaging(Increase the Value by a fixed Amount)

Value Averaging

Month Unit Price

Total Value(RM)

# of Units to Own

Units Obtained

Amount Invested

(RM)

1 1.00 1,000.00 1000.00 1000.00 1,000.00

2 0.60 2,000.00 3333.33 2333.33 1,400.00

3 1.40 3,000.00 2142.86 -1190.48 (1,666.67)

Total 2142.86 733.33

Average cost per unit

RM 0.3422

Thoughts and consideration before applying DCA, VA and DAA

• Choosing the right vehicle(Unit Trust instead of individual stocks)

• Choosing the right Unit Trust(choose an equity fund that reflects the benchmark that we wanted)

• Switching Fee

• Investment Time Horizon

• Time involved vs. income earned to monitor and switch funds

What would Benjamin Graham thought about it

• “The majority of investors should be satisfied with the reasonably good return obtainable from a defensive portfolio”

• “To achieve satisfactory investment results is easier than most people realize”

Lessons Learned

• Lesson No 1: Start Invest Early

• Lesson No. 2: Plan for a Reasonable Rate of Return

• Lesson No. 3: Use a system (DCA, VA or DAA), and not “guessing” the market’s direction.

• Lesson No. 4: Force Yourself

• “The Greatest Enemy of a good plan, is the dream of a perfect plan”

Carl von Clausewitz

Questions

&

Answers

system investment strategy through market turbulence

Economy & Finance