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5 Ways To Generate More Alpha On A Portfolio
We run through different ideas ranging from selling covered calls to taking cross-asset exposure, aiming to boost returns.
Make use of income generating potential through selling options and reinvesting dividends.
Put spare cash to use, even on short-term time deposits given the higher interest rates.
Diversify away from just a US stock base via different asset classes and geographies.
Besides the core principles around building a long-term sound stock investment portfolio, other actions are needed beyond the buy-and-hold approach. Some are relatively straightforward to implement, while others require some work. Ultimately, we feel all of the below points can help to enhance the return on a portfolio.
1. Selling covered calls
For investors that mostly have a long-only portfolio, selling covered calls can be a good way of generating income. This refers to selling a call option and receiving an upfront premium, on a stock you already own.
Let’s say you own shares in Tesla, which you bought at $150. the price is currently $165. You could sell a one-month call option at $180, and receive a 1% premium (not live pricing). If the stock stays below $180, you pocket the 1%. If it trades above $180, then you will sell you Tesla shares at this price. Even if this occurs, you’ll have profited in the difference between $150 and $180.
Granted, it’s an inconvenience to have to sell if the price jumps through your strike price. But if you’re careful with the strike level you pick and the timeframe you take on, it can be a useful way of pocketing additional income.
2. Making use of free cash
It’s unwise to be fully invested at any one point of time. A portion of a portfolio should always be held in cash to take advantage of potential opportunities as they arise.
Yet given the move higher in interest rates, investors can make use of short term time deposits or money market funds to make this cash earn more. Below shows the 4-week Treasury Bill yields at present:
Even by putting funds on a rolling 7-day time deposit, the yield pickup versus the non-existent interest on cash accounts can make a large difference over the course of a year or more.
3. Reinvesting dividends promptly
Various stocks pay out dividends to investors, and a portion of any portfolio will probably be geared towards income investing. Yet one point that some forget about is the process of reinvesting dividend income quickly.
When a dividend is credited to your account, some sit and wait for several dividends to accumulate before taking the money and buying more shares with it. Rather, if we get paid a dividend from X company on a Monday, we want to invest it back into the company on Tuesday.
This allows the value in the stock to compound quicker. Then when the next dividend comes around, it’ll likely be larger given that the previous dividend was used to buy more shares in the firm.
4. Go global for growth
Home bias in investing is a very real and a very negative trait that many unfortunately have. This is natural, as we all have an affinity towards investing in stocks that we know and that are domestic.
Economic data over recent months highlights why this is a problem. Global growth is becoming more unsynchronised. The US are still likely to head into a recession this year, yet the Eurozone is performing well. China reopening is boosting growth prospects, yet the UK is struggling with inflation still above 10%. The divergence in inflation rates as just one metric is shown below:
To generate more alpha on a portfolio, analyse the geographical split of current holdings. If it’s concentrated on one area, look to diversify across the globe. This will help to avoid getting caught up in one country that underperforms in the coming cycle.
5. Have cross-asset exposure
Even for those that just want to be focused on stock investing, putting a portion of money to work in another asset class can help to generate alpha.
Traditionally, bonds and stocks were inversely correlated, which provided a great combination to include as a hedge for an investor. This did break down last year (see below), so it should be taken with a pinch of salt.
At the moment, we like taking on exposure to gold and the broader commodity space, as well as FX. Getting exposure to FX via a fund or ETF is possible, or learning to trade FX as an asset class on its own can be considered too.