Sunday, October 11, 2015

How to beat the STI index ?

A lot of other blogs talks about the virtues of the STI ETF index ( ES3 ).

For most beginners, buying the entire index makes sense. As ETFs generally have low management fees, holding the ETF for a long term yields solid dividends and you get to make a general bet on the Singapore economy. 

But what if you are an intermediate investor and want better performance on the STI index?

One way is to understand that the STI index is a capitalization-weighted index. This means that the position of an individual stock when you buy the index is proportional to its market capitalization which is its (stock price x number of stocks). Anyone who buys the index is in essence always buying a larger proportion of stocks which has done well previously as its market capitalization has gone up before. 

One possible winning strategy is to buy individual STI stocks in equal proportions. You undertake a slightly higher risk for better returns because you refuse to overload on  a stock which has already been bidded up by the markets. 

The evidence can be found in the performance of two indices : The SPY index is the S&P 500 index which is capitalization weighted. The equivalent equal-weighted index, with code RSP based on statistics in Yahoo Finance, currently outperforms the SPY index by an annual rate of 0.18% over 5 years but over 1% over 3 years. This out-performance can be large if you hold your portfolio over several decades.

The problem with creating an equal-weighted STI portfolio in the past was that 1 lot was 1000 shares. These days, with 1 lot being reduced to 100 shares, your largest stock position would be 100 shares of Jardine C&C which would cost you about $3,149. With 30 stocks in the STI, you might be able to create a crude equal-weighted STI portfolio with just $100,000.

Considering that you also avoid paying a 0.3% management fee of the STI ETF, this strategy may be worth a try if you already have $100,000 in that STI ETF counter.

NB : Do watch your brokerage fees which would amount to 0.75% so make sure you can hold at least 3 years for your savings in management fees can offset the brokerage payments. 

NB : Unfortunately, I did not have the time to test whether there is outperformance on a Bloomberg terminal for local stocks. Readers who backtest please share your results on this blog.

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