How do you invest in equities? What are the advantages and disadvantages of buying shares directly, choosing investments via active or passive funds? How long should you look at holding onto equities and what are the signs that it’s time to sell – or buy?
First of all, there are several ways to invest in equities, depending on your level of expertise, cash and availability.
“I would say that buying shares directly is a good idea if one has the insight and is well-researched, since you really need to keep up with the market trends,” says Kaushiq Kodithodika, a UAE-based regional sales director at SS&C Advent Solutions, a company offering technology to investment managers.
However, for less experienced investors, it may be a good idea to purchase equities via active funds. Those are managed by a fund manager, whose job it is to research and select stocks from a wide range of companies, with the aim of outperforming a benchmark such as the local market index, therefore making the investment decision on your behalf.
It is also possible to invest in so-called passive funds. Such funds track a market index and an investment in them involves no trading, but buying all of the assets in a particular market to give a return that reflects its performance.
Passive’s aggressive growth
Passive funds have become very popular in recent years. Data from Refinitiv shows that actively-managed funds, including ETFs, attracted $445.1 billion of new funds in 2018, but active managers handed back $282.9 billion of funds to investors (excluding money market funds).
There are pros and cons to direct, active and passive investments.
Kodithodika said one of the advantages of a direct portfolio “is that you can control and rebalance your portfolio and, of course, there are no fees”.
Meanwhile, although passive funds offer greater diversification of risk than direct investments, and relatively lower charges than their active counterparts, returns will only match those offered by a market, he adds.
“Active funds, on the other hand, aim to outsmart the index but come with higher charges, since you are paying someone else to do it,” Kodithodika says.
“Directly buying or selling equities has become easier but you need to do a lot of research, while buying active or passive funds allows you to buy units, mutual funds, etc – all of them are easily available through providers,” he adds.
“In a mature market, you would rather go with passive funds, while in emerging or frontier markets, active funds make better sense. The market’s maturity is key as fund managers’ access to emerging and frontier markets are constrained.”
Defensive vs. cyclical: the importance of balance
Investors planning to buy equities directly are advised to avoid taking on too much risk by spreading their investment across a number of companies. A balanced equities portfolio should have a mix of stocks, ideally from different geographies, exposed to different currencies and varied sectors.
It is also recommended to hold a variety of safer and riskier stocks, as the latter potentially offer higher returns in good times.
So-called “defensive” stocks, because they act as a safety net in troubled times, can help to balance a portfolio once a market enters the doldrums or becomes volatile. In the Middle East and North Africa (MENA) region, defensive stocks include companies that will likely always get business from, or are supported by, the state, such as energy and utility companies, airlines, banks, telecoms and pharmaceuticals companies.
Cyclicals, on the other hand, include stocks that are more exposed to the consumer cycle, or the overall performance of the economy and as such tend to be more volatile. These include technology, consumer staples and construction stocks. However, any stock is subject to market fluctuation and intrinsic narrative and there is no such thing as a 100 percent safe investment.
As Hasnain Malik, head of equity research at Exotix Capital, says, investing in a developing economy like the United Arab Emirates comes with a range of challenges and a good understanding of the local market and conducting diligent research is key.
“UAE equities have generally performed poorly because of concerns on excess supply of real estate in both Dubai and Abu Dhabi and deceleration in white-collar population growth. The exceptions have been stocks which have seen their weights in mainstream indices used by institutional investors, such as MSCI EM, increase substantially as a result of an increase in foreign ownership limits or mergers. This is not a recurring phenomenon. Our preference is for stocks which are trading at very cheap valuations and are exposed to the completed parts of the Dubai economy, such as Aramex, Emaar Malls and DP World.”
Time is of the essence
Investors also need to carefully consider the time horizon for any equity investment made. They should identify whether they are looking to hold a specific stock for a short term, or whether they will buy and hold it as a longer term investment.
“Long-term holding strategies for direct investments in equities seem to be best, while short-term strategies require skills, attention and deeper analysis,” Kodithodika says.
“One of the risks of direct equity investment is that, due to lack of attention to the market or domain, you may lose significantly or miss opportunities due to market movements, while investing in funds reduces this factor as the fund managers are paid to watch the market and make timely decisions,” he adds.
As to when to buy and when to sell, this is obviously no exact science but some signs include a change in the macroeconomic, political or fiscal environment, how the stock is valued, any change in a company’s circumstances such as a new leadership, the launch of new products or changes to its sales performance and outlook, and foremost, whether the investor holding the stock can continue to tie up the cash as an investment.
Either way, it’s important to remain emotionally detached from an investment and not to panic at the first sign of downward pressures on a stock or a wider marketplace.
To invest in equities safely and benefit from key advice, it is important to use the services of a reputable and accredited local equity brokerage or asset management firm.
In the UAE, the Securities and Commodities Authority (SCA), Dubai Financial Market(DFM) and Abu Dhabi Securities Exchange (ADX) all provide a list of licensed and active brokers on their respective websites.