Every day, millions of trades take place and billions of dollars exchange hands in the global financial markets. Every second, there is new information flowing through the financial markets and reflected in the trading activity. Investors need to be able to differentiate what is valuable and what is noise in building a robust investment portfolio that can capture the returns and withstand the risks. At Providend, the investment process starts with its investment philosophy.
An investment philosophy is the foundational framework that guides an investor in examining the financial markets and constructing investment portfolios. At Providend, a lot of thought and hard work has been put into this important framework to ensure the resulting investment portfolios are constructed with the same rigorous standards employed at some of the most sophisticated institutional investors (such as sovereign wealth funds).
There are four pillars that embody the Providend investment philosophy.
1. Economic contribution
The first pillar is the belief that for an investment to generate long term returns, it must participate in and contribute to global economic production. In other words, there is no free lunch. Investment returns are generated from the value created through positive contributions. If an investment does not create any added economic value, then we should not expect there to be long term investment returns. Furthermore, the amount of return an investment generates ought to be consistent with the amount of risk it takes.
For example, equities and bonds are the two most common investment instruments. How does an investment in the form of equity or a bond participate in economic activity? First, both equities and bonds are ways for investors to provide capital to a company to conduct its business activities. The company is expected to create value to its customers through the services or goods it delivers. Investors receive returns if the business is successful; and investors lose money if the business is not successful. How are equity and bond investors compensated as compared to the amount of risk they are taking? It is also commonly known that equities are expected to have higher returns than bonds. This is because equity investments are exposed to higher risk than bonds, since bond investors get paid before equity investors (equity investors only claim the residual payment after bond investors receive their payments first). This dynamic between return and risk is often referred to as the risk-reward tradeoff.
2. Empirical observation
The first pillar enables Providend to focus on long term drivers of investment return that are consistent with their contribution to economic activity, instead of investment based on market speculation. The second pillar is data driven: Providend further evaluates and validates an investment idea with real market return data observed across multiple economic and market cycles. The Providend team evaluates the empirical return evidence to determine if they are consistent with what we expect from pillar one. If an investment meets both pillar one’s and pillar two’s considerations, then the confidence that it will be a robust investment option is much higher than if only one of the two considerations is fulfilled. Using the same example, since the 1920s, US equity returns are around 10% on average per year, and bonds returned around 5%. While equity return was higher on average, it was much more volatile on any given year; therefore, producing a much higher likelihood of losing money than bond investment. Similar numbers can be observed across many other developed and emerging country markets. These empirical observations not only validate pillar one with real life observations, but significantly increase the confidence and the level of our understanding in their risk-return tradeoffs.
3. Implementation
Pillar one provides the foundation and pillar two provides the evidence that guides how the Providend team examines investment risk-return tradeoffs. The next step is to construct the portfolio. There are a number of important items to consider in the implementation phase. For example, the portfolio should be well-diversified and not overly concentrated in any particular investment. Diversification has been proven to be the only effective way to enhance a portfolio’s risk-return tradeoffs. In addition, Providend aims to minimize the investment costs per unit of return we expect to receive. The lower the costs, the more the net return. In this implementation phase, the Providend investment team carefully examines all the qualified investment options along diversification, costs and other dimensions to ensure that the portfolio is well-positioned to efficiently capture the returns.
4. Practical considerations
To apply the above three pillars in building an investment portfolio, it is also critical to consider the goals and preferences of the investor (family). Afterall, the success or failure of the investment portfolio is not only reflected in its risk-return tradeoffs, but also reflected in its support of the family life objectives. At Providend, an experienced team of wealth advisers work hand in hand with families to identify and prioritise those important considerations, whether it is saving and investing for a comfortable retirement, or for educational spending, or for other life objectives. Each family is unique, and Providend starts the investment advisory process by carefully understanding those unique needs and preferences and treats each family with the utmost amount of care and due diligence.
Providend has put the interest of the client at the forefront since its founding almost 20 years ago and has helped many families to meet their wealth management goals. As a fee-only wealth advisory firm, Providend works solely to help clients and families achieve their objectives, not for the interests of any other parties. The Providend team will continue to develop and advance its capabilities to provide the best unbiased investment solutions to investors.
From left to right: Dr Peng Chen | Mr Cheng Chye Hsern, Head of Investment Team
This is an original article written by Dr Peng Chen, Senior Advisor and Director of Providend Holding Pte Ltd. The edited version has been published in the The Business Times on 3rd April 2021.
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