Investment Portfolio Strategies

June 10, 2013 10:45 am

How-Stocks-Can-Diversify-Your-Portfolio

The Aggressive Portfolio

Aggressive portfolios generally consist of riskier assets, mainly stocks, and aim at long-term higher returns. Such shares typically have a higher beta, which represents the correlated volatility of an asset in relation to the market as a whole. Basically what beta shows is how the particular asset will react to a certain movement of the market. The beta coefficient is used in the Capital Asset Pricing Model, which calculates the projected return of an asset by taking into account its beta and the expected return of the market. The higher the beta of an asset, the higher the possible returns are. Therefore investors prefer such assets for their aggressive portfolios. An example for one of those can be seen below.

Of course, you can have aggressive portfolios with a higher or lower percentage of equities. Such a portfolio with around 50% of equities is called a Moderately Aggressive Portfolio and some refer to it as a “balanced portfolio”, since the amount of fixed-income securities and equities is almost equal.

You can also have an aggressive portfolio that consists of more than 80% equities, whose sole purpose is huge capital growth over long time. Investors refer to such as Very Aggressive Portfolios.

Most stocks with high betas belong to fairly new companies that are in their early stages of growth and still lack reputation. Such companies must offer something special in return as a value proposition so that they can attract venture capital. Investors who are seeking such uncertain, but high profit need to spend some time finding companies that aim at rapid growth and still haven’t been found by others. In many cases, especially in the last 15-20 years, most of those firms belong to the technological sector where, as history shows with many of the corporate giants, one good idea is all what is needed to earn the trust of risk seeking investors and expand rapidly.

The Defensive Portfolio

The defensive portfolio follows the conservative concept of portfolio forming. It consists mainly of fixed-income securities and holds stocks, which opposite to the aggressive strategy, carry a smaller beta coefficient (near zero) and are generally isolated from broad market fluctuations. Fixed-income securities by default have fixed and secured payments because when a company files for bankruptcy, the creditors are the first in line when liquidation takes part. Here is an example for a conservative portfolio:

An investor might choose to reduce the share of fixed-income securities in his portfolio in order to be less exposed to inflation surges. This can be done by investing in equities at the expense of fixed-income securities. For a defensive portfolio this means going for blue chip companies, as they carry less risk, which would be in consonance with the conservative strategy. Investors refer to such portfolios as Moderately Conservative Portfolios.

As for the stocks that are held in these portfolios, they are mainly connected to companies, which produce essential products and services since they are more resistant to economic shocks. In most cases, companies in the pharmaceutical, beverage, food, tobacco sectors and other “basic” goods producers will survive during a recession as demand for their production remains relatively constant.

The Hybrid Portfolio

The so-called hybrid portfolio is a more flexible and diversified strategy and extends to holding a wider range of assets such as commodities, real estate and even art. Its core values are safety, liquidity, income and favorable risk/return proportions. These portfolios traditionally include blue chip stocks and high grade government or company bonds with different maturity as well. These portfolios rely on fixed allocation proportions between multiple maturity bonds and stocks as balance is sought through their negative correlation – losses from one asset type are offset by other’s profit. Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs) are also being selected.

An MLP is a publicly traded limited partnership that consists of two types of partners. A limited partner is the person who provides the capital and receives periodic income payments from the MLP’s cash flow in return. The other person, the general partner, is the one who is responsible for managing the MLP’s affairs and is compensated in accordance to his performance. The most crucial criteria for a partnership to be classified as MLP is that the source for 90% of the cash flows must derive from commodities, real estate and natural resources.

The Income Portfolio

An income portfolio’s main goal is to generate positive cash flow and provide investors with current income through dividends or other types of distribution. These portfolios are particularly appropriate for retirees and other risk-averse investors as they ensure additional regular income. Companies, whose stocks are selected for such portfolios, are generally like the ones chosen for a defensive portfolio, but they offer higher yield. Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs) are an excellent example of an income producing investment as they generally pay out most of their profits back to shareholders and receive special tax considerations. Companies from the utilities and other slow growth sectors, which have lost the general investor’s interest, but still have stable and secure profits and maintain a high dividend policy are in most cases preferred for this portfolio.

The Speculative Portfolio

This is the portfolio with the highest risk among the ones we already noted above. According to finance gurus, the main principle that is in play here is to bet not more than 10% of one’s investable assets on high-risk investments, which are near to gambling. Such investments are for example Initial Public Offerings or stocks of companies that are rumored to be under takeover in the near future. Other investment targets of speculative plays are companies in the technological and pharmaceutical sector, which are close to inventing an innovative product. A lot of research is required in order to do the proper move here, but if an investor gets it right, such investments bring huge return in a short amount of time. People generally use speculative stocks to trade them in short-term and profit through the price difference, instead of going for the classic “buy and hold” strategy.

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