Here’s what retail investors can learn from the investment and portfolio management strategies used by institutional investors
Humans by nature are risk-averse in all aspects of daily living. They want to take good care of their health, relationships, jobs, and financial well-being. Such characteristic clearly manifests when it comes to stock investments.
Many people would love to dip their hands in a market that offer handsome financial rewards. But because there is the possibility that losses can be greater than gains, it becomes undesirable. But with the success of institutional investors, retail investors want to learn their strategies and use them.
The stock market is one of the best investment options if you’re trying to build wealth. But you have to remember too that retail and institutional investors face the same market risks. It’s only the amount of investment that differs.
ALL investors are risk-averse
Don’t think for a moment that institutional investors are not risk-averse. Losing is not an option when you’re moving a substantial amount of capital. In truth, they are extra-cautious yet absolutely optimistic. Their financial success lies in their investment and portfolio management strategies.
The strategies used by this smart breed of investors allow them to efficiently manage stock portfolios and grow the funds despite the market volatility. Retail investors can be equally successful. The same strategies can be learned and adapted to achieve individual financial goals.
Investment & portfolio management strategies of institutional investors
Institutional investors manage a pool of funds belonging to other people or groups. They carry a mandate and obligation to invest those funds in various assets. A greater portion of these funds is generally invested in equity issues. Since the size or volume of the funds is huge, they can exert influence in the financials market.
A retail investor does not manage other people’s money but his or her own. Therefore, the client is you. Basically, you have the same objectives as the institutional investors. You have to act in the best interest of the client at all times. More importantly, you are expected to optimize the allocation of the funds and enhance returns on investment.
Is one type of investor better than the other? Amir Hamzah, Assistant Director, Investment Advisory, iFAST Global Markets explains, “Institutional investors are perceived to be better investors as they have large full-time professionals working for them. They have larger capital and are able to have more access to financial instruments typically not available to retail investors. However, there are still some strategies that are utilized by institutional investors that should be applicable to the retail investors.”
Sean Cheng, Portfolio Manager at Providend, agrees and explains that institutional investors typically have many strategies available to them due to the size of the assets that they manage. “These are usually active strategies, which include alternative investments such as hedge funds, commodities managers and private equity. These alternative investments are usually costly to invest into due to the high fees that are paid to the managers of such funds, and retail investors seldom have access to them.”
Here are some other investment and portfolio management strategies used by institutional investors that can be applied by retail investors:
1. Know the market dynamics
Institutional investors spend long hours analyzing the investment landscape. Whether it’s the stock exchange, bonds, mutual funds, and other investment instruments, research and market study is an ongoing concern.
Clients will rely on the extensive market knowledge of fund and portfolio managers. In the same light, retail investors should follow this mandatory strategy before engaging in any investing activity.
When you have a good grasp of the market, you will be in a position to identify the potential risks. The moves of institutional investors are always calculated, with no hasty decisions because they know the market dynamics.
2. Focus on the investment objectives
The best institutional investors follow a well-crafted investment philosophy. At the onset, financial objectives are set and established. Included is a clear investment time frame. Based on these objectives, they will work to balance risk and reward.
Sean Cheng, Portfolio Manager at Providend, suggests adopting the 3-Rights investment philosophy: Right Mindset, Right Portfolio and Right Advisor.
“The Right Mindset is to invest for the long term. The Right Portfolio is cost-efficient, globally diversified and has a proven track record of satisfactory returns across decades – such as a passive index fund. And the Right Advisor has interests which are totally aligned with yours – meaning that he or she does not take hidden commissions from selling you products, but instead earns a transparent fee from providing you a clear service.”
He further adds, “Having the Right Mindset, Right Portfolio and Right Advisor would give you the greatest probability of enjoying a successful investment experience.”
Aside from ensuring strict compliance with the investment roadmap, they set benchmarks or limits on returns for every type of asset. In effect, it’s a way of exercising discipline while simultaneously containing the element of greed.
3. Learn to diversify risks
Some institutional and retail investors still miss out on the guiding rule of investing. Never put your eggs in one basket. If you fail to abide by this familiar advice, you can’t expect better returns.
There’s too much danger if you invest in assets that possess the same risks. When it comes to asset allocation, you should fill your basket with a broad selection of risks, not just on one risk factor.
A diversified portfolio is a way to actually increase returns and minimize risks. The practice of concentrating on a particular asset class was prevalent before. Eventually, there was realization it only magnified the risk exposure. A fresh concept of risk management came about that is completely opposed to conventional wisdom.
Today, smart investing is not about selecting assets. You pick the assets and accept the inherent risks. If you want to manage a stock portfolio, the safest way to protect your money is to select stocks from different sectors or industries.
That is what prominent institutional investors are doing now. They are able to spread risks because investments are distributed in variable and fixed-income asset classes.
4. Monitor your portfolio
Institutional investors are relied upon by the beneficiaries to judiciously monitor their investments. Conducting a periodic and timely review of the portfolio’s performance is a must. That is the only means to measure how far or near the investments are to the risk and reward targets.
Retail investors should also learn the habit of diligently monitoring their stock portfolios. The pressure is heavier on large institutional investors because they are accountable to several clients. But if retail investors can be as thorough and systematic, their proficiency level can be comparable.
5. Reduce risk exposure by rebalancing investment
Apart from the well-timed review of their portfolio’s performance, institutional investors are proactive when it comes to maintaining their target asset allocation. They are skillful in rebalancing portfolios.
As much as possible, they want to toe the line. There shouldn’t be any deviation from the established investment route. Periodic rebalancing means there’s a constant mix of investments whenever the situation calls for it. The objective is to reduce risk exposure in relation to their target asset allocation.
6. Investment Policy Statement (IPS)
Amir from iFAST Global Markets adds to the list, noting the importance of the Investment Policy Statement (IPS).“All institutional investors have some sort of an IPS. Basically, these are guidelines on their investment process. They have risk/return targets, constraints of their portfolio (EG: How much investable capital can you set to each sub sector of an asset class) and manager selection criteria (expense ratios, 3 year Sharpe ratio, etc).”
“For the retail investor, their IPS should include their investment goals, how much they intend to invest, how much potential returns they are seeking, the type of investment tools are they utilizing and their strategies,” he advises.
“In short, retail investors need to quantify their investment goals.”
7. Asset Allocation
Amir also commented that all institutional investors have sophisticated asset allocation models. “Typically, their investment committees meet regularly to discuss about the economic landscape, update their strategic asset allocation and may use some tactical moves to exploit short term opportunities for each asset class over the next 6 to 12 months.”
For the retail investor with limited capital and perhaps also limited time, Amir from iFAST Global Markets stresses that asset allocation becomes even more important.
“However, for the retail investor, instead of looking at the economic climate, they may want to base their asset allocation on their individual risk profile and time horizon. Their benchmark for potential returns AND volatility should be based on the long- term average of the different asset classes.”
8. Passive Index-Tracking
Sean from Providend finds that investing with a passive index-tracking strategy could prove to be very useful to prevent massive losses. “In recent years, many institutional managers have been pulling their funds out of such investments because they have been vastly underperforming simple passive index funds, such as Vanguard’s S&P 500 Index fund.”
He cites the example of Joseph Torsella, the state treasurer of Pennsylvania who accused the Pennsylvania Public School Employees’ Retirement System and Pennsylvania State Employees’ Retirement System of wasting billions of dollars in fees to Wall Street investment managers whose funds badly underperformed. “They could have saved US$3.9bn and US$1.6bn in fees respectively if they had simply invested with a passive index-tracking strategy,” Sean concluded.
“Retail investors have access to passive index-tracking strategies too. Vast amounts of money have been pouring into passive funds in the past few years from both institutional and retail investors alike, but in Singapore this trend has yet to take hold.”
The disciplined approach is the key
There’s nothing wrong if retail investors try to be like institutional investors. It makes sense especially when the institutional strategies work most of the time. Retail investors can build an investment portfolio by starting with a small budget then set risk limits.
But more than the strategies, discipline is more valuable.
“Have a disciplined process to investing and have faith in the process,” was the reply given by Amir when asked for one piece of advice he would give to retail investors. “Often, the emotional component of investing is what caused retail investors to underperform or even lose money. Time in the market beats timing the market.”
The Assistant Director of Investment Advisory of iFAST Global Markets further elaborates, “In a study by Dalbar, the average US equity fund investor achieved an annual return of 5.3% over the past 20 years compared to a gain of 7.2% for the S&P 500. In another study by Fidelity Investments on their Magellan fund from 1977-1990, Peter Lynch’s average annual return during this period was 29% over the 13 year period. Unfortunately, what Fidelity Investments found was that the average investor in the fund actually lost money.”
Understanding the entire investment process and the accompanying risks is easier. But if retail investors can embrace the disciplined approach that institutional investors use, achieving a financial goal or retirement needs is not far-fetched. That is the secret behind their winning ways.
Regardless of the strategy or the type of investing approach one chooses to take, TJ Tan from DCG Capital offers sage pieces of advice for retail investors:
- Invest only in things you can understand.
- Minimize cost – Reduce trading turnover
- Don’t spread yourself out over too many stocks