Thursday, March 11, 2010

Agile Software Development Approach to Investment Portfolio Management

Most people in the software development field would have heard or used Agile Methdology, which is basically an iterative and incremental framework for software development with envolving requirements. Fans of Agile would love it so much that the traditional waterfall method is often cited as uneffective. I disagree with this view but that is left for another day as this is an investment blog.

However, basically what I am going to share here is that Agile methdology can be implemented for investment portfolio management, especially when using the concept of buy and hold strategy and adding new funds into the portfolio with limited funds every month. There are few reasons to this. Agile is an interative process and portfolio management is also an iterative process. Attractiveness of a stock can change and one's investment portfolio needs to be re-visited regularly too. One's capital to invest every month can also change, and if one subscribes to the buy and hold strategy with RSP, they are doing incremental additions to the portfolio every month. So, in a sense, Agile fits well into buy and hold strategy.

In Agile, we have a backlog which consists of a series of stories. Similarly, we have a list of selected stories in the backlog for investment portfolio management. These stories are changing every now and then in the backlog, based on what you have in your shortlist. The stories in the backlog are ranked, which means the first one on the list is the most attractive in your view, and the next one the second most attractive and so on. Basically, one should have already done the necessary fundamental analysis and diversification consideration on these stocks before you rank them in stories. The stories can be for example: "Buy 1 lot of SIA", "Buy 2 lots of Colex", "Buy 1 lot of Innotek" etc.

In each sprint/iteration which lasts for example, one month, an investor will decide on how much velocity (i.e. money) that he wants to invest for that month. After that, he will do an estimation of the stories that he could fit in for this sprint and draw them out from the backlog, starting from the highest ranked one. Let's say your velocity for this month is $1000, but Story 1st in the backlog is "Buy 1 lot of SIA". Obviously, your $1000 is not enough for Story 1st although SIA is the most attractive stock at this moment, based on your FA. Therefore, you give Story 1st a miss and move on to the next story, i.e. "Buy 2 lots of Colex". The process goes on until all your velocity (i.e. $1000) had been used up. So, there it is, you have done your planning on what to invest for your $1000 this month. Repeat the process for the next sprint. Remember to update your backlog regularly too.

The above is just one small example on how you could utilize Agile for investment portfolio management. Practically, there can be several variations like shortening your sprint cycle to let's say two weeks to cater to a portfolio which can be more responsive. One could also set up a few scrum teams - One for Cash Investment Portfolio, another one for CPF Investment Portfolio, another one for SRS Investment Portfolio etc. Each of these scrum teams should consists of different backlogs.

Eventually, it is up to the investor to define all these, and a well-groomed backlog of stories is critical for sucessful implementation. Which means, your FA skills is still the most critical part. Agile only helps in planning what stories to commit to complete every month based on your available velocity, but it doesn't help you to select your stocks.

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Blogger Royston said...

Interesting...a very systems-thinking approach to investing. I did software engineering last time so can kindof relate to your methodology. I've heard of the waterfall approach but not the agile approach to software development, didn't go into the computer industry after graduation.

Just wondering, does your system also incorporate a process for selling of stocks?

Btw, I've changed the hosting of my blog to blogger instead. Can help to update the link on your blogroll?




3:13 AM  
Blogger ghchua said...

Hi Royston,

Yes, you can. Suppose you plan to drawdown $1000 at the start of the sprint. Just set velocity = -$1000. So, your stories should be like "Sell 1 lot SIA", "Sell 2 lots Colex" etc. Again, you need to rank the backlog of stories accordingly, starting with the most attractive stock to sell. Which means, the most attractive stock to sell is the one that is most overvalued in your view after doing your FA.

You can even combine buy and sell stories in your backlog. Let's say you set velocity = $1000 at the start of the sprint. It doesn't mean that you can only buy. You can sell too, if you rank your sell stories ahead of buy stories in your back log. Just remember to add onto your velocity after you plan in your sell stories and deduct from your velocity after you plan in your buy stories.

The aim of course at the end of the planning is to have your velocity all used up as much as possible - i.e. near to zero.

Updated the link already. :)

10:41 PM  
Blogger Royston said...

Hi Ghchua,

Thanks for updating the link! :)

I understand that you have raffles education as one of your top 10 holdings, any views on its current status?

As in its earnings seems to have dropped drastically. Yet it seems to be expanding very aggressively.

4:29 AM  
Blogger ghchua said...

Hi Royston,

As you can see, it had already dropped a few places in my top holdings for the past few months.

I guess for a diversification strategy that I am using, you should not read too much in my top holdings. I have not added onto Raffles Education since I took an initial stake in the company a few years back. Its place in my top holdings currently is purely on share price appreciation and partly due to the Hartford Education takeover offer which I had accepted.

Yes, its earnings had dropped and it is still expanding. Cash flow from operations is still positive but growth is not as great as a few years back. I guess when you reached some size, it is difficult to continue growing at a rate that is expected of them a few years back.

To be very frank with you, I am not really concerned about their drop in earnings. Rather, what I would like to see is for them to further reduce their debt in their balance sheet.

7:14 PM  
Blogger Sennett said...

Interesting system that you have implemented, how does it affect your turnover rate and the amount of commissions paid using this system? Wont it be quite substantial if the lots you buy arent large enough or if the system allocates to too many counters?

7:36 AM  
Blogger ghchua said...

Hi Sennett,

If you have velocity, you won't be concerned about the brokerage. In fact, the agile method focus on velocity. If you have no money (aka velocity), then there is no turnover to speak of no matter how long is your backlog of stories.

So, therefore, ultimately, this system still require velocity, which comes in a form of salary, dividends, takeover, selling stocks etc.

Many people are concerned about commissions. But they don't understand about incremental approach. Yes, you might be hit with minimum commission when your trading size is low but you can be hit with massive losses if you say, buy a small cap stock at a high with one lump sum just to save on commissions.

Ultimately, the aim of this system is not to generate trade based on short term market movements, but to adopt a long term buy and hold strategy with incremental changes. They key word here is "incremental" and not massive portfolio turnovers.

Therefore, there will not be intra-day trades using the system but rather small but comfortable incremental changes over time to adopt to market conditions.

In fact, if you hold a decent stock long enough, the dividends that you received throughout the period that you hold the stock should be able to pay off your initial commissions when you bought the stock.

Hope that the above clarifies.

8:43 PM  

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A self-directed investor, looking to invest for retirement needs and bypass all those expensive financial planners/insurance agents. Investing is fun, profitable or most important of all, knowledge gained is useful for the rest of your life!

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