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The Different Asset Classes Available for Active Investors

 

A look at the various instruments available for an active investor.

Previously we introduced two forms of investing: Passive investing vs Active investing. If you are not too sure about the differences between the two, take a read on the previous article first to determine which is most suitable for you.

Active investors speculate on the movement of the market price by longing (buying) the security in the hopes of price rising, and short-selling the security in the hopes of price falling.

Equity

There are different types of equities securities such as common shares, preference shares and convertible preference shares.  Common shares are the most common form of equity. Shareholders have ownership interest in the firms and are able to vote on key matters such as the appointment of the board of directors, merger and acquisitions decisions, and appointment of external auditors.

Firms are not obliged to pay dividends to common shareholders and management has the discretion to determine how much dividends are to be paid. Shares listed on the SGX trade in volume of 1,000 shares each.

Coy ABC(SGX) Volume Trade price Last price Profit / (Loss)
Long 1,000 $3.00 $4.00 $1,000
Short-sell (1,000) $3.00 $4.00 ($1,000)

Preference shares pay periodic payments (not contractual obligation) to investors and do not usually come with voting rights. It can be viewed as a hybrid between common shares and fixed income securities.

Convertible preference shares can be exchanged for common stock at a conversion rate which is pre-determined when shares are issued. Firms with higher risks usually issue convertible preference shares as a way to compensate investors for the additional risk undertaken.

Debt securities

Debt securities (commonly known as bonds) represent promises to pay periodic payments for a given number of years with repayment of the principal amount made at maturity. You can read up more on debt securities here.

Accrued interest is payable by the buyer if the bonds trades between coupon dates. The buyer will receive the next coupon payment and pay accrued interest to the bond seller. Full price = Clean price + Accrued interest.

Exchange traded funds (ETFs)

ETFs are funds that trade on an exchange like a normal stock. The underlying investments of the fund can be made up of equities, fixed income, commodities and etc (physical or synthetic).

ETFs track its designated index, attempting to replicate index performance. Hence management fees are usually lower compared to an actively managed fund.

The main motivation for investing in a fund (either ETFs or unit trusts) is diversification. There are currently 96 ETFs listed on SGX and some are specified investment products (SIP) that can only be traded by retail investors with a certain level of investment knowledge.

ETFs holdings are disclosed on the fund managers’ websites on a daily basis and market price can be obtained through the exchange.

Unit trusts

Unit trusts gather and pool money from investors to invest in different types of asset classes, subjected to the investment objectives of the respective unit trust. Unlike an ETF, a unit trust is not listed on an exchange. Actively managed funds aim to outperform a particular benchmark index.

An active investor can take the approach of buying unit trusts that cater to one’s risk profile, and allow the fund manager do the work of active investing.

Find out how passively investing in ETF compare to an investment in a unit trust.

Foreign Exchange (Forex)

Forex trading is often associated with high volatility and leverage. Forex trading is done through choosing a currency pair, and speculating on the movement of the exchange rate. Margin levels can range from 50:1 to more than 10,000:1 which means it allows a trade value for $50 for every $1 in the account.

Below is an illustration of how forex trading works, assuming that a forex trade is going long on CAD/USD:

Sep-13 Oct-13 Profit/(Loss)
Buy Sell Sell Buy Profit
1000 CAD 970 USD 1000 CAD 990 USD 20 USD

Which asset class is suitable for me?

As retail investors, risk profiling is important to ascertain the level of risk tolerance one can assume before considering the different asset classes. Transaction costs can also be very high when one is actively investing. Understanding the different asset classes available is the first step to active investing.

If you would like to understand your risk profile or have some questions about investing, feel free to use the JustAsk platform below to connect your questions with industry professionals.

 

Royalty-free photo from Getty Images. Used with appreciation.

 

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