Trading With A View

Author: tradeview   |   Latest post: Sat, 4 Jul 2020, 2:00 PM


(Tradeview 2020) Principles of Investing - Rule 3 : "Diversification is the Best Defence"

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Dear fellow readers, 

Once again, these writings are just my humble highlights (not recommendation), feel free to have some intellectual discourse on this. You can reach me at :

Website / Blog : http://www.tradeview.my/
or Email me to sign up as private exclusive subscriber : tradeview101@gmail.com

KLCI rebounded strongly and broke 1400 to close at 1407 on Friday 17th April. KLCI reach a high of 1414, around 2%. This was quite surprising given how oil price WTI has fallen below USD 20 per barrel to US18+ and Brent retreated to USD 28+ per barrel. That is what the equities market is all about I supposed, irrational. If the market is always efficient, then there are no opportunities for investing and trading as the price will always be at an equilibrium. 

Now as we are fast approaching the end of April and wishfully the MCO, many seem to be quite bullish about the market or otherwise it is "Fear of Missing Out" (FOMO) that is pushing the market uptrend momentum. Of course some attribute to the fact that US is talking about slowly opening the economy again as they claim they are past their peak cases for Covid-19. Floods of good news in global markets are also abundant as touted by promoters of stocks across various telegram channels / groups. This is not the case for us. 

Maybe by nature, we are contrarian. I supposed most value investors or fundamentalist would be, given the current actual current market conditions. We genuinely believe artificial support of the market does not last and will not reflect the actual fundamental of the economy. Have a look at the picture above which to us a true oxymoron and ask yourself, "How can US market have the best weeks of gain since 1938 but at the same time, more than 16 millions have lost their jobs in the past 3 weeks? Something is wrong somewhere isn't it?"

We can have a debate endlessly on this topic without arriving anywhere. Believers of the bulls have totally forgot how the market was when it plunge all the way towards 1200 in March just few weeks ago. People are generally forgetful. If history teaches us anything, it always returns with a vengeance and strikes like a lightning bolt. So here comes, if you are torn and is uncertain or unsure with the market direction, what should you do? 

1. Risk on - enter the market and hope for the best (for market to continue rallying); or

2. Risk off - stay on sidelines and hope for the best (for market to plunge); or

3. Stay invested whilst holding sufficient cash to average down (best of both worlds)?

I am sure most of you would choose option 3.  So how do you execute your investment strategy if you choose option 3? In my view, you cannot do it without sufficient diversification. Risking everything and putting all in one basket is akin to gambling, not investing. So what in actual fact is diversification? Simple as it may sound, there are different extents of diversification. I will share with you all through a simple illustration with some of our stock picks. 

1. Diversification within same sector

Let me use the example of oil and gas. In 2019, the oil and gas companies were really roaring back to life with the likes of Uzma, Carimin, Serba Dinamik, Yinson, Hibiscus, Dayang, Perdana amongst others leading the way. Whoever that caught on the wave probably made close to 50-60% return within 1 year. Some exceed even that of 100% if they entered companies where notable investors has substantial position and highly promoted by investment banks or syndicates. Today as we know it, oil market has plunge ferociously and those who have existing position who did not take profit in 2019 would suffer the sell down in 2020. Those lucky enough to have exited quickly would have been able to protect their profit. 

So how do we diversify? Oil and gas sector is divided to upstream and downstream. There is the process of exploration & extraction, the process of refining and the process of retailing. In addition, there are the storage facilities, supply of equipment, maintenance of equipments, FSPO charters and others. So what I meant when it comes to diversification within the same sector means you should not put all your investment in one sector in one part of the the value chain. If you do choose to invest in oil and gas industry, you cannot throw all your money into Hibiscus which is primarily in exploration and extraction. When  the oil market is good, they will do well and hit above RM1 as in 2019, but when oil plunge, it dropped almost 80% of the value to 20+ sens. Hence, you should consider allocating your investments into different part of the value chain. An example, for us, we like put our investment in Yinson (FSPO charter), Dialog (storage facilities), Uzma (maintenance). 

2. Diversification Across Sectors

Now moving on, this is what we have always advocated and used often. We like to put our funds in different sectors and it actually helped us weather past crisis such as 1MDB, oil crisis, GST, Election, Brexit, Trump and today. Don't get me wrong, it doesn't mean we didn't lose money. In fact, even if we make losses, the losses are able to be carried by the winning investments. Let's not look too far, and put it simply for 2020, the stocks we have mentioned in previous articles.

We have funds in :

1. QL & CCK (poultry / essential retail), 
2. DKSH (Consumer), GCB (Chocolates grinder / commodities), 
3. RHB & Public Bank (Banking), 
4. Allianz (Insurance), 
5. Scicom & Pentamaster (Tech / E&E) 
6. MFCB (power plant & resources)
7. OCK (telecommunications) 
8. RCE Capital (Finance)

If you look at our list above, it is vastly different and it is definitely not in one single sector. From our list you cannot even tell which is our favourite sector. This is one of the reasons why conglomerates are usually strong in times of weakness because their exposure in various sectors help them cover the weakness in certain aspects. The Korean chaebols is a good example where they stand very strong for a long duration of time over the years and various crisis as they are protected from cycles through each different business division. 

3. Diversification of  Investment Strategy

As a continuation to the above list of stocks, from our list, if you look very closely, you can see we have a diversified our investment strategy such that we do not invest with one single modus operandi. We have combined investing based on the stock's earnings yield, dividend, growth.  

Example : We invested in RCE Capital for the Earnings Yield, Scicom for Dividend, Pentamaster for Growth.

This is another form of diversification. This form of diversification is closely related to diversification across sector as using different focus on investment strategies would usually means you have to pick out from a basket of stocks belonging to different category of industries. 

4. Diversification of Asset Class

This last bit is not complex. Many I am sure knows the 30:30:40 rule. 30% savings, 30% investment & 40% expenses. Now use the same logic into asset class of products such as :

1. Cash
2. Equities / Stock
3. Fixed income / Bonds
4. Commodities / Gold
5. Pension / EPF
6. Amanah Saham / Tabung Haji (For the bumiputera)
7. Real Estate / Property

Noticed, I did not put insurance and cryptocurrency in the above asset class. This is because I do not believe in cryptocurrency and for insurance, I believe it serves a different purpose, i.e. not investment. Insurance to me, is for the safety net in the event something bad happens and best to purchase vanilla products instead of investment linked products when it comes to insurance. However, this is topic for another day. The short video below gives a simple illustration of Diversification. 

Do stay tune for my next write up, "Principles of Investing - Rule 4 :  "Scaling When Buying Falling Stocks"


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Food for thought: 

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  4 people like this.
Erudite Tq
20/04/2020 11:20 PM
gohkimhock good write-up bro. For small time retail investors, I will always advise to concentrate the fund on 1 to 2 counters only. Study the financial statements properly and do not speculate.
20/04/2020 11:52 PM
VenFx This article can be a must article to collect, to remind me the Investing Diversity .
26/04/2020 12:34 PM
zhangliang Interesting read. likey!
26/04/2020 2:38 PM
qqq33333333 defend and attack..........

diversification as defense........but all defend no attack, how long can win?
26/04/2020 3:45 PM
Junichiro The best option is sell off early n cut loss. I do not think diversication can help in face of the big global plunge.
26/04/2020 4:42 PM
stklearner Since diversify, sell early, cut loss, helps to protect against unexpected big loss, i try to do all n see how, tq
26/04/2020 4:57 PM
VenFx Agree Junichiro sifu,

I hv been practising it since 2H2019
It work out extremely good to me.

Teamview sifu s article on how to successfully plan for a diversified portfolio equally important to benefit from a sector Chain.
26/04/2020 6:09 PM
Junichiro Hi, I am not sifu. The truth is if u are flush with cash when the KLCI plunged to the bottom, u would have make money by buying some dirt cheap shares. When u are flush with cash, u would be more comfortable taking a bit of risk.
26/04/2020 7:40 PM
klmly2 He (Armada An Quantum Leap Stock In 2019/2020) called many people as sifu.
btw, he bought high and keep to low, all risk taken. Brave guy
26/04/2020 8:38 PM
VenFx Agree Junichiro,
A realisation for 70% of the initial ,upon share price appreciate by 60% or above... a very good cut win point .
26/04/2020 8:58 PM
VenFx If, not i wud not able to gain big from armada.
26/04/2020 8:58 PM
qqq33333333 diversification as defence..... not true..... since all the stocks are correlated
26/04/2020 9:31 PM
qqq33333333 the real important decision is cash or shares
26/04/2020 9:32 PM
klmly2 I thought we lost 70% because of Armada??
Gain big 50% is last year, but this year over lost about 70%

Posted by Armada An Quantum Leap Stock In 2019/2020 > Apr 26, 2020 8:58 PM | Report Abuse

If, not i wud not able to gain big from armada.
26/04/2020 10:43 PM
Junichiro A fund manager has to diversify because he is managing other ppl's money. He is paid to do the job. Nobody paid him to keep all the investor's funds in cash. At times when he should have disposed his entire portfolio, he is not able to do so. Hence, he has to diversify.

Whereas, when we are managing our own money, why is there a need to diversify ? Diversification does nothing to protect you from a loss since the whole market is going deep down.

"The nature of risk" by Justin Mamis, a former executive at the NYSE is good reading. I think you download it in the net for free. I still have this hardcover book in my library.
27/04/2020 9:29 AM
Junichiro A fund manager has other means to cut risk other than diversification.

It was reported in Nov 2019 in WSJ that Ray Dalio's hedge fund has placed a bet north of $1 billion that global stocks will fall by March 2020.The position is made up of put options that could pay out to Bridgewater Associates if the S&P 500, the Euro Stoxx 50, or both drop in value (Put options are contracts that grant investors the right to sell stocks at a predetermined price by a specific date.)
27/04/2020 9:49 AM
zhangliang Wah u all talk like expert. How normal retailer can buy derivatives ? And buying derivatives super risky. Don’t simply teach people if don noe. Best to be humble to learn. Qqq333, sure can hold cash, hold gold hence the article wrote there diversification of asset class man. Already written there y u repeat wat people say. Aiyoooo
27/04/2020 4:23 PM
gohkimhock hold construction and building materials counters.
27/04/2020 5:02 PM
Philip ( buy what you understand) In my humble opinion it is always far more important to buy what you understand than to diversify for diversification sake.

The key word here being understand. If you don't understand the business, diversification can easily lead to DIWORSIFICATION.
29/04/2020 11:17 PM

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