If you were invested in equities during the “meltdown” of 2007/2008, what could you have done to improve your position? You could have sold everything and moved to bonds or cash, or just stayed in equities and hoped for the best. The first option probably wasn’t all that enticing: bond yields were plummeting at that time, and cash deposit interest rates were also going down as central banks slashed interest rates in a concerted effort to thwart the meltdown. More so, because of the high gas prices, inflation was higher than bonds or cash yields, and equities, well, you know how it went. Looking back, don’t you wish you had more options than you actually had?
Investing takes many forms; we should already be familiar with instruments like cash deposits, bonds, and equities. But in today’s rapidly changing financial world, investing in more complex financial instruments is becoming more and more common, and even necessary, to reduce risk and/or maximize profits. Diversification is still a very good idea, and having more options at your disposal will ultimately benefit you and your wallet in the long run.
This first part of three will introduce you to investment products, ranging from “common” investments to more complex instruments that are readily available to retail investors. Aside from the already familiar equity investments, we will also take a look at Exchange Traded Funds (ETFs), options, forex, contracts of differences, and hedge funds, among others. While this article does not, in any way, presume to be authoritative, at the very least it should pique your interest enough to make you want to read more about these investment alternatives, and perhaps eventually invest. At any rate, I will go ahead and say that past performance is not indicative of future results, and that I do not guarantee any kind of profits by investing in some of the examples I have provided.
Introduction
In more developed and mature markets, alternatives other than the usual cash deposits, bonds, and stocks are available to individual investors. Some instruments, like options, allow you to hedge or reduce your risk by capping your maximum profits while providing “downside” protection. Downside protection means that you are protected, to a certain degree, if the market goes down, but at the expense of capping some of the gains you might have in case it go up. Other instruments allow you to profit while the market is in the red (shorting). These instruments have always been available in mature markets, but unfortunately unavailable here in the Philippines.
There are several reasons why we don’t have these instruments here: lack of liquidity, lack of investors, and fundamentally, lack of a good investing environment and plenty of local economic issues. As such, to be able to access these investment products, you need to convert a portion of your portfolio into another currency like USD or EURO. For the sake of simplicity, I will use USD as my “other currency” for the rest of the article. Once you have your new currency, you can have access to a broader range of investment products that will enable you to profit from any direction the market is going. Take note though that investing in any instrument not denominated in your base currency (that is, the Philippine Peso) is subject to something called currency risk, or the risk that your assets will lose some value because of fluctuations in exchange rate.
I’m interested, so where do I go?
You go to the US, where all the action is. It is home to the New York Stock Exchange (NYSE), and the NASDAQ, two of the biggest exchanges in the world, which boast a combined 6000+ listed stocks. These stocks include common names like Procter & Gamble, small penny stocks, car manufacturers, logistics companies, and even overseas companies like our very own PLDT (which is listed on the NYSE). Prominent companies that have a significant global presence would have naturally diversified revenue streams reflected in their stock prices. Buying FedEx’s stock, for example, provides you with a natural hedge against risk since the company does not rely on its US operations alone, but also on its extensive global network. Many of these “global” companies are listed on American exchanges, some of which provide more income potential through dividends than growth. Of course there are exceptions like Apple, Inc., whose groundbreaking products like the iPhone and the iPad fueled the almost 100% increase in the stock’s price in the last 12 months.
But with thousands of stocks to choose from, which one should you invest in? The answer is really up to you. Some industries are better suited for growth than others, such as Biotechnology and Healthcare. You can look at Yahoo! Finance which offers very good information and up-to-the-minute news about an industry or specific companies. It also provides handy ratios such as earnings per share (EPS) and price-to-earnings ratio (P/E), among others. You can also go to EDGAR Online to get Financial Statements of listed companies.
Another very interesting investment instrument available in the US is the Exchange Traded Fund or ETF. In a mutual fund or UITF, the fund manager pools and invests money into instruments of his or her own choosing. The value of the fund is measured as Net Asset Value (NAV) or Net Asset Value per Unit (NAVPU), and is determined by the value of the underlying assets. The value of ETFs on the other hand, is freely determined by supply and demand forces, just like common stock traded in exchanges like the NYSE or the PSE: you then earn when the price of the ETF rises, and lose when it falls.
ETFs have become hugely popular, and have thus spawned many different kinds and variants. The most popular ETF, the QQQQ (PowerShares QQQ Trust), tracks the NASDAQ 100 List, which consist of the 100 largest and most actively traded companies on the NASDAQ. Since the NASDAQ is tech heavy, this ETF is a good investment if you are looking for long-term growth prospects in the tech industry. Other kinds of ETFs are more “exotic”, like the ones traded by ProShares. Some of their ETFs track gold, oil, or other commodities, sometimes even a basket of commodities. They have ETFs that double the daily return of several indexes, or even double the inverse of those indexes or commodities. Buying into these inverse ETFs is an easy way to short an index, without actually having to select the shares and apply for broker approval on shorting.
Investor Juan frequently suggests buying index funds, which is an excellent idea: index funds are low cost and are diversified among Philippine companies. But how about investing in not just Philippine stocks, but stocks all around the world? iShares is another company specializing in ETFs, and they have the S&P Global 100 Index Fund which tracks the performance of the S&P Global 100 Index, which consists of the world’s 100 highly liquid and globalized companies. Or how about China? If you’ve always wanted to invest in the Chinese stock exchange but didn’t know exactly how, you can buy one of their ETFs that track Chinese stock performance.
To sum it up, ETFs are cheap and usually not-actively-managed funds that can be easily bought by a retail investor. You just need a broker, and there are many to choose from. Look for one that allows “Non Resident Alien” investors. You should also consider going to discount online brokers and not to full-service brokers because of usually lower commissions, and you probably don’t need a broker-assisted trade anyway (do everything online!). You should also compare commissions: some have free trades per month if you fall under a certain category, so be sure to check it out.
You can open accounts at ETrade, TDAmeritrade, Fidelity, Schwab. These companies are members of SIPC (Securities Investor Protection Corporation) which is like the FDIC for your brokerage account. They usually cover $500,000 per account, but most have coverage in excess of $1 million. Take note that they do not cover your account against trading loses. They will only protect your account should your broker go under. Some of these discount brokers are even listed companies so they should be generally safe.
To be continued… (next: short selling, options, forex, etc.)
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Billy graduated from Ateneo de Manila University’s Management Engineering program in 2008. He's the current operations head of Helix Technologies Inc., a local IT solutions firm, and also the manager of his family's manufacturing business. He built his investment experience from the ground up, doing small investments here and there, although his short stint at AB Capital Securities definitely helped.