My 30+ years spent in the markets have covered times of great upheaval and times of great stability. I was trading when the Asian Financial Crisis hit, when tech got routed in the DotCom Bubble and when banks and governments almost imploded during the Great Financial Crisis. I was also trading through times of great stability in the markets, regardless of what was happening in the wider world. There are important lessons in both.

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I set up one of the first hedge funds in Asia, where my focus was on arbitrage strategies. These are strategies which are typically well hedged so that the volatility and risk of loss is low. It often has one of the highest risk adjusted returns in the industry. After several decades running my hedge fund, I became CIO of a Family Office where my focus was the preservation of capital and long-term returns. 

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There are three main things to look at when investing in general and creating a portfolio in particular:

Risk adjusted returns 

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• Its important to contextualise portfolio returns. A 10% return on its own sounds decent, but it needs to be considered alongside the overall volatility and in relation to the broader market. Generating a 10% return when the markets return 25% looks less appealing. 

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• More sophisticated measures will look at drawdowns and within these are measures such as the Sortino ratio. 

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• I also heavily leant on stress tests to actively test the effect of certain market moves on my portfolio. I felt that stress tests most accurately reflected the risks of my portfolio as it captured movements both small and large. It also highlights an important part of portfolio creation: uncorrelated returns. That is – what instruments in my portfolio act as a hedge and thereby reduce my overall risk?

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Leverage

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• Almost every market crisis can be traced back to leverage. It is the ingredient that turns a bad loss into a crisis. Put simply, if you are unleveraged, then the market needs to drop 100% for you to be wiped out. Markets, as a whole, have never dropped 100%. If you are 2x leveraged, then the market only needs to drop 50%. Markets have dropped 50% a number of times. If you are 10x leveraged, then a 10% drop will wipe you out. Markets have moved 10% in a day. 

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• When looking at either a position or a portfolio, one should pay attention to amount of leverage being taken, with special attention being given to positions that are leveraged and why leverage is being employed? Is it simply to enhance returns? 

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Some instruments are inherently leveraged. The technical term for this is gearing and most often refers to options, futures and CFDs. This is because you can lose more than the capital invested in the instrument. 

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Position sizing

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• Related to leverage, but more specific to positioning, correctly sizing a position will result in either forced exit, or being able to withstand and take advantage of market fluctuations and come out the other side.

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• Its rare that you are going to enter the trade at exactly the right time. As a result, you are probably going to enter the trade and then experience a temporary loss. As a general rule of thumb, it’s a good idea to size your position in such a way that allows you to buy into the same position (called averaging-in) once more. In my experience this meant sizing around 75% of what I initially wanted. For example, if I wanted to buy $100,000 of Amazon, I would first buy $75,000 knowing that if Amazon falls more I can afford to buy another $25,000.

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I don't claim to have invented these concepts but they are certainly similar to traits I have seen in other successful managers and individual investors. With illio, my intention is to bring these professional grade tools to help the individual investor.

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