If the crippling financial events of 2008 and 2009 proved one thing, it's that investors need to rethink the entire philosophy of "portfolio management."
Today, the best-performing managers around the world manage their portfolios based on broad-and-potent market themes. And with good reason.
It's much easier to follow macro trends based on broad-based themes than it is to cobble together a bunch of different stocks into a portfolio and call it diversified. Theme-based investing is also much more profitable. And it allows you to better manage your risks.
In short, theme-based investing lets you have your cake and eat it, too.
When you follow themes you get the big picture. Your timing may not be perfect. But when you invest on a thematic basis, it's much easier to determine the direction of a trend, as well as momentum and velocity of price changes.
Every study I have ever read bears this out. It's not principally the actions undertaken by a company that determine most of the movements in the price of a share of its stock. Research proves that price activity is chiefly a function of the trend of the overall industry, as well as the overriding trend of the general market.
If you think of a theme-based portfolio as a cake, it might have seven slices:
- A slice that encompasses the developed markets of the world.
- One flavored by the world's emerging markets.
- A slice formulated from key commodities.
- One containing a healthy serving of technology.
- A slice sprinkled with a thorough helping of health, medical and pharmaceuticals.
- One with such basic ingredients as dividend-yielding stocks and fixed-income holdings.
- And a final slice with a decidedly speculative flavoring, that might include options.
Theme-based investing is a powerful concept. And these seven may pack the most potent profit punch in the new year. Each of these seven individual slices will also contain several layers. These layers can consist of the crème de la crème of individual companies, or of benchmarked exchange-traded funds (ETFs) and indexes that track the general theme of that particular slice of your portfolio.
The U.S. investing landscape is far from being over-the-hill.
You will invariably find leaders in their fields with strong balance sheets and great growth potential in the domestic basket of stocks. And you will layer these companies in each of the seven slices of your portfolio cake. But remember, there's a big beautiful world out there, so don't get hung up on allocating capital only to U.S. stocks.
You may be comfortable with domestic companies, but it's imperative that you get acquainted with global opportunities.
Your slice of developed-world international cake should have you looking at Canada, Europe, Australia, and Japan. There are global brands that are domiciled in these countries. Some of the layers in each of your other slices may include some of these big names. But it's also a good idea to get some direct exposure to other developed countries through ETFs, or by investing in the currencies of those non-U.S. economies. There are ETFs and other investment vehicles that can give you good, liquid exposure to currency investments.
That brings us to slice No. 2: the emerging markets.
Face it, if you're not invested in the world's emerging economies, you are behind the times and missing out on what the smartest investors in the world are labeling "the future of investing." You should, if possible, allocate capital into China, India, Brazil, Korea, the Pacific Rim, and look for opportunities in Russia, Latin America and Eastern Europe.
With emerging countries developing rapidly – and the rest of the world still working to wake from its post-financial-crisis slumber – the demand for commodities (the third slice) will far outstrip any supply for commodities. And that's why you need a heaping helping of them.
Whether you make an allocation to commodities because of the supply-and-demand equation, the prospect of downstream global inflation, or the short-term fact that more money managers are allocating capital to hard-commodity assets, you've got to follow this theme.
Your layers need to include gold, metals, agricultural commodities, mining companies, and oil and gas. And don't forget about water – the often-forgotten commodity that will be in very short supply in the years to come.
Investing in technology, the fourth slice, should also be an easy choice. Technology is where the world is and where it's heading. Technology changes everything – so much so that you must have an entire slice dedicated solely to tech.
The layers in your tech slice should include the hottest themes out there – themes that are pushing breakthroughs and that are capable of creating paradigm shifts.
Everyone caught a glimpse of the tech train before it derailed in 2000. That locomotive is once again chugging at a good speed and headed toward massive profitability.
The case for the No. 5 slice – healthcare, pharmaceuticals and biotechnology – is an easy one to make. Have you ever been sick? Have you ever known anyone who's been sick? How can you not love a market that has billions upon billions of customers just waiting for its products to come to market? The medical and pharmaceutical companies that deliver health solutions are going to explode in this decade.
And that's before you even factor in the impact of healthcare reform.
You can make the layers of this slice even more palatable by spreading some capital across different segments, including some of the up-and-coming research-and-development (R&D) firms, growing and diversifying healthcare and pharmaceutical giants, generic-drug manufacturers, service providers and distribution channeling firms.
Sturdy global corporations in fast-growing business segments, commodities and emerging markets are a good start. But the confection should also put money in your pocket, even when the greater market isn't exactly cooperating – meaning you still need income.
That brings us to the sixth slice: dividend-yielding stocks and fixed-income instruments.
However, income alone isn't enough. Ideally, this slice of cake should include investments with reasonable yields that also present the potential for capital appreciation. Layer this slice of cake with good-yielding dividend stocks. In doing so, however, don't go for the crazy yields that clearly aren't sustainable. Look for solid-brand-name companies with a history of dividend growth. Look for fixed-income ETFs that are stable and sturdy.
But beware. This slice of the cake needs watching.
If interest rates start to rise, your fixed-income investments may take a beating. The layers in the income slice of cake should at times include hedges against rising rates. The good news here is that a flexible strategy will protect you in an environment with rising rates or escalating inflation, and will also generate huge profits if timed properly.
For the final piece of your portfolio, have a slice that's mostly frosting – speculative plays. Maybe there are takeover candidates that you're willing to dabble a little in. Maybe use this slice to incorporate some option positions, invest in some private-equity plays, or to invest in a particularly hot hand that you're already playing.
The key to watching this slice fatten your wallet is to not get greedy. Cut your losses quickly and don't be afraid to take some profits when they're in hand.
Remember, speculative positions are not "investments" in the traditional sense; they are defined plays that usually get stale if you leave them out too long.
You can bake your own cake or you can find a money manager to work with you. If you don't have time to compile all the ingredients and watch your cake while it's in the oven, make sure your money manager understands what it is you want. Make sure they adhere to your philosophy of cake-baking. Make sure that they explain every layer they are baking in and how it's going to make the whole cake taste.
And last but not least, make sure you get to eat your cake.
Take profits and diversify into more layers, but don't add so many layers that each slice is piled high with thin prospects for the sake of calling your portfolio diversified. All great-performing managers – and by great I mean managers that vastly outperform the averages – have more concentrated portfolios. If you insist on buying a fund related to the Standard & Poor's 500 Index, buy an index ETF (good luck with that).
But if you want a truly diversified portfolio – with powerful profit opportunities – stick to big themes and layer in the very best ingredients.
Happy New Year and happy investing!
[ Editor's Note : Shah Gilani is a retired hedge-fund manager and a leading expert on the global financial crisis. In March, Gilani predicted that a strong rebound in U.S. stocks was in the offing – a forecast that proved to be both timely and accurate.
In November 2008, Gilani warned investors about five key credit-crisis "aftershocks" that threatened the health of the world economy and stock markets – but that, if played correctly, also posed some of the best profit opportunities in years. Each of the five predictions played out just as he projected. To check out Gilani's aftershock predictions, please click here.]
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.