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Investing in the best ASX Shares and minimising risk to sleep at night

Richard Hemming

Investing in ASX shares requires courage. Under the Radar shows you how to reduce the risk of your portfolio so that you get the benefits of investing in high growth Small Caps as well as the long-term benefit of investing in the stock market. We give you the tools that the big end of town use.

Why the ASX Share Market is at a record high

We’re all having success in these days of share market euphoria, so that it is easy to forget how despondent many ASX Share investors were at the end of last year when the market, or S&P/ASX Ordinaries Index had fallen 10% in the space of a few months.

An image of a man sleeping

Back then, the US Federal Reserve head Jerome Powell was still working out the difference between doves and hawks, but interest rates were unequivocally going up as the monetary policy screws were being tightened in the wake of unprecedented loosening. In fact, many considered the screws were too tight. All the while the fears were growing that the US/China trade war would put in jeopardy global economic growth. Added to this, tech valuations were being compared with the Y2K bubble. We all know how that ended.

The comment Powell made in the first week in January to the effect that we can be patient regarding further tightening meant no more rate hikes for most, trigging a bout of buying, which we don’t seem to have seen the end of. In fact, he has poured more oil on the fire until his hawkish comments this week.

Is the ASX Share market due for a big correction?

Now some share investors are scared the other way, ie that we are due for a big correction. I don’t share those fears. If history is anything to go by, the time to sell isn’t when the market is at record levels, particularly when central banks around the world are cutting interest rates. The market could well have a long way to run.

The point is, to sleep at night you want the market to do what the market will do, and have some fun on the side, investing in stocks that you have some knowledge of and think are undervalued, and leave some cash aside for a rainy day.

How you can protect your ASX Share portfolio

To do this you invest some money in a share market related investment, giving you what the boffins call “beta”. The market is represented by indexes. In Australia’s case, the benchmark is most often the S&P/ASX 200 Index. An example of this “core” approach is investing in some 60 stocks, but the transaction costs would lampoon your returns. Achieving diversification is important, but not at any cost! The best strategy is to invest in an index linked ETF or a Vanguard fund which replicates the index. Doing this achieves diversification at a low cost.

The best strategy is to invest in an index linked ETF or a Vanguard fund which replicates the index. Doing this achieves diversification at a low cost.

Under the Radar Report runs two portfolios – a Blue Chip portfolio, which will have between 25 and 35 stocks; and a Small Cap portfolio which currently has 18 stocks in it, plus an ETF replicating the price of gold (GOLD).

Using Small Caps to generate better than ASX share market returns

These concentrated share portfolios are designed to add what the industry terms “alpha” which means performance above that experienced by the market.

The average return of the S&P/ASX 200 Index is close to 10% a year over the long-term. These concentrated funds aim to deliver better than this, and in fact are, by some margin.

Choosing the Best ASX Shares: Small Caps give you alpha

If you are investing to achieve “alpha” the benefits of diversification ratchet up when you go from one to 10 ASX stocks. After this it’s returns are diminishing. You want to own between seven to 10 ASX stocks on your own.

Last, the benefits of Small Caps, which we define as being below $500m in market capitalisation are clear. The “core” or “market” (in this case the S&P/ASX 200 Index) does not include these companies, so their returns are less correlated to the index. If the market down, some of these Small Caps could well go up, which lowers your overall stock market risk.

There is not one right answer for everyone because every ASX Share Investor has a different tolerance for risk. If you are risk averse you would put a greater portion of your funds in the core portfolio, for example. If you are able to embrace more risk, you would put more money into growth assets.

About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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