Reflecting back on Year 2008, I think it will go down in history as a very significant turning point in the global economy. I also think that, due to events in Year 2008, other developed economies and emerging economics will evolve in different way. By different way I mean with reference to how it interacts with US economy. For the last few decades US economy was the engine of growth for global economy. US economy with its ingenuity, entrepreneurial business environment, innovative mindset, institutions, and rule of law was the global consumer. The other economies were happy being the supplier. Moving forward, this status will be challenged depending upon how US policy makers deal with the aftermath of events in 2008. While US business environment is still very much entrepreneurial, it remains to be seen how it will adapt to the new economic environment. History shows it has always adapted. Time will tell if it does this time also? By no means I am professing dooms day scenario, all I am saying is things will be different than what/how it used to be. How different, I do not know.

We individual investors in India need to put Indian economy in the context of global economy and understand where we are heading, what challenges we expect to face. Once we know that, then investing for our long term portfolio will be relatively easier.

On the subject of investment performance, blogosphere is filled with differing opinions, views, solutions, rants, etc. To me, cribbing about current state of affairs and blaming US financial centers, or US governments policies will not give me a good portfolio performance. We all make mistakes. The key is learning from our past mistakes and adapting. I believe what individual investors like me need to do is look at their own investment strategy and processes, put it in the context of current state of economy, evaluate against your goals, identify shortcomings, and adapt accordingly. Having said this, I spent some time measuring my income portfolio performance against my objective. Here I am discussing few important ones that I believe has significant impact on my income portfolio.

(1) Continuing to Stick with My Investing Process

Year 2008 was a very good test case to show me that my investing process works for me. It continues to suit my needs, my risk profile, and my long-term objectives. All of my performance metrics (such as passive cash flow, yield on cost, annualized XIRR, and portfolio value) continue to do relatively better than my benchmark index. Year 2008 did show few kinks in my investment process which I am going to address in year 2009. The two significant issues were (i) lack of appropriate risk metrics; and (ii) continued changes in market whacking my asset allocation.

(2) Risk Management should be tied to Objectives

The general off-the-shelf prescription of using diversification and asset allocation for portfolio risk management is becoming a cliché. Year 2008 showed that for individual investors perhaps none of them works. For my portfolio, the primary objective is to generate increasing passive cash flow. With all the continued fluctuations of interest rates, volatility, dividend changes, I realized the need for appropriate metrics for measuring risk for passive income cash flow. I still have not figured out the metrics, however, I am introducing the limit that income from a given position should not exceed 5% of the total portfolio’s passive cash flow.

(3) Asset Allocation will be Effective only with Rebalancing

Establishing the risk management metrics for the portfolio is only a first step. It is necessary to also identify the execution method. So far my approach was to stop investing in a given position after I reached limits of my allocation metrics. However, 2008 showed me that it is important to sell partial positions to rebalance rather than stopping investments. Sell the partial position and use the money to invest in other opportunity on waiting list. However, this is contrary to long term philosophy of buy and hold. I am still pondering what is appropriate for my income portfolio. Leave your views or suggestions in comments section as to how it should be managed for a income focused portfolio. Let us begin the discussion.

(4) Remove an Apple Gone Bad from the Basket

I should be willing to sell a stock if it does not meet my buying objective or when its fundamental position has changed. Like a rotten apple spoils the whole basket, one stock could be a drag on your portfolio performance. Buy and hold should apply only until the stock is meeting its objective in the portfolio.

(5) Continue to Watch Business News

Watching financial pundits talk has a great entertainment value. It is really fun to watch analyst after analyst coming and creating sky-is-falling scenarios (and offering solutions). Additionally, if interpreted with a sane mind, it tells you exactly what not to do. Do not panic, they are paid to create these scenarios.

The above points are the ones which I believe has/will impact my portfolio management process. These learning are for my process and may not be same for others or may not be applicable to others. In the spirit of shared learning, if you have any other unique learning or what changes you made to your process then leave your comments below or send me an email at income.portfolio@gmail.com

reflection, risk