MPL guide to diversification (2011)
- 1. GUIDETO DIVERSIFICATION This guide isdesigned to help start you on the road to spreading the portfolio over a range of di erent asset classes, each of which reacts di erently in building an investment portfolio. With a little consideration, di erent market environments. By broadening a balanced, well-diver portfolio should weather the a portfolio’s exposure across a range of asset classes, it is likely that, at any one time, some short-term storms of stock market and property market may be rising whilst others may be falling. As a result, some of the caused by most . It will smooth out the many peaks and troughs economic and events can be smoothed and help you meet your objectives over the longer out as the two movements, to an extent, cancel each other out. The same is true of investment term without causing too many shocks along the way. risk. For example, whilst all shares have a similar exposure to sentiment in the stock market on which they listed, the inv risk An introduction varies from company to company – that is the Diver is a much used term in the shares in each do not move in exactly the same world and one that can be employed direction by exactly the same amount, at the at many levels. Most fund managers claim their same time. In the same way, therefore, there is aim is to diversify risk by investing across a some smoothing of returns as each share moves range of di erent stocks or shares, even when di erently from the rest. their universe is quite small – for example, a smaller companies manager with perhaps only This all sounds like good news but you also need 400 potential investments to choose from to consider the other side of the coin. If you would suggest that his hand-picked selection of invest across di erent asset classes then, when 70 o ered diver . one asset class is thriving, the fact your portfolio holds others asset classes as well will act to At the same time, it is the job of a lower the return which it could have achieved. adviser to help you diversify your portfolio by This might lead you to the question: ‘how guiding you through the range of di erent assets diver should a portfolio be’? and allocating your portfolio across the di erent options to help you meet your objectives whilst The answer depends greatly on your attitude to also staying within your acceptable level of risk. risk. We can assume, quite ly given the lessons of history, that no one person is able to accurately predict the performance of markets “This might lead you When looking to invest, no matter what to the degree where they know exactly where to the question: ‘Just how the asset class, there are risks. These are to be invested at any point in time. If it were predominantly made up of two aspects: market possible, we would all be millionaires. Therefore diver should a we use diver to e ectively hedge our risk, the impact of economics or government portfolio be’?” changes, and investment risk, the uncertainty bets. The extent to which we need to do this and volatility of returns. Diver can depends on how much volatility we can deal help to reduce both of these risks. Market risk with – how much we tend to worry or panic cannot be eliminated but can be reduced by when the value of our portfolio starts to fall.
- 2. SPREAD OUT YOUREGGS OVER MANY BASKETS! Any portfolio can be diver . However, remember that stocks and utilities such as water and electricity companies as the market forces driving these when you diversify your portfolio, risk is not the only thing two sectors can be completely di erent. that you will lower. You will also lower the level of return However, as they are both listed on the stock market they are both subject to what a ects which you would have received if you were 100% invested the overall equity market, such as the impact of a government’s monetary policy, or , as in the best asset class only. The skill comes in balancing your well as overall investor sentiment. asset allocation so that the relative payo matches your Diversify by geography own attitude to risk and reward. Geography also allows some of the impact of stock market movements to be dissipated, as Spread out your eggs over many you are not exposed only to the economics and baskets! government decisions of one country. Di erent So, that is the theory. In practice, once you know markets are a ected by di erent economic and what you can deal with, the e ectiveness of the factors and are therefore not perfectly diver strategy depends on considering correlated with one another. If the Far East does the degree of ‘correlation’ between various badly, it does not necessarily mean European elements in a portfolio - or in simple terms how stock markets will. And within Europe there is ‘together’ investments move – and combining the possibility of even more diver by them appropriately so that the overall geography as not every stock market in Europe movement is in line with your expectations. moves with the next. For instance, xed interest investments can be Yet, all equities can be impacted globally, seen as a safe haven when markets are rough particularly when investor sentiment is involved and equities are volatile. Property, on the other – consider the impact of the boom in telecom, hand, has tended to protect against media and technology stocks in the late 1990s, over the long term, whilst also not moving in followed by their subsequent collapse. The e ect line with equities. Then there is cash, which of this was global – although markets such as depends entirely on interest rates for its level of the US, which had greater exposure to these income, and government bonds. Each responds sectors, were impacted more heavily, almost all di erently to external such as interest countries su ered from the somewhat depressed rates and equity environment during the bear market of “The ectiveness of 2000 through to early 2003. your strategy depends on Diversify with asset classes considering the correlation Within each asset class there are further between various elements of opportunities for diver . Within equities, The same can go for xed interest investments your portfolio.” for example, the returns of some companies (bonds) and property. For example, government versus others are not related in any way. bonds, particularly those of investment grade Generally speaking there is little correlation countries such as the US or UK, do not tend to between the performance of say biotechnology operate in the same fashion as sub-investment
- 3. BRINGING ITALL TOGETHER When looking at proportions, this is where many consider simple processes such as, for example, a core/satellite approach. grade corporate bonds, which are issued by less elements - asset class and geography. If you are ly secure companies. Within property making your rst steps into investment, or have meanwhile, even commercial property and only a small amount to invest, you can hand Typically the core portion makes up the residential property are not always correlated in over even more of the decisions by targeting the largest part of the portfolio, is relatively the returns they o er. broader portfolios of global equity or managed less volatile and is designed to provide a funds. Within these, not only does the fund solid base on which to build. The satellite What to put in your basket manager diversify by type of company and investments then add the spice to the Generally, the place to start for most investors is their respective weightings but they also look at portfolios by taking smaller positions in to consider your attitude to risk in some detail. country weightings – and usually, some element higher-risk regions, asset classes or sectors. If you could not live with the of of asset allocation as well. the stock market and would be very worried For a lower or medium-risk investor, their by the sight of prices going down, then you are Note core portfolio might be concentrated in very low-risk and your portfolio should consist Property is a specialist asset class and expert cash, bond and property funds or perhaps of fewer risky assets - cash and maybe xed advice should be sought before making a an equity fund linked to larger, highly interest. decision to invest. regulated stock markets, such as the US or the UK. The satellite element may then If you are comfortable with a little movement, The value of any market or property investment access varying high yield bond, equity or and are investing for the long term, you may can go down as well as up and you may not get sector exposures at lower weightings. include a small element of equity exposure. back the amount originally invested. Alternatively, if you are at the opposite end of the scale – a high-risk investor, who is perfectly happy with the ups and downs of markets – then you would most likely have the majority of your portfolio in equities. Using mutual funds “Mutual funds already er Mutual funds by their very nature already o er some diver as they some diver as they hold a number hold a number of erent of di erent securities, generally in a particular securities.” market, sector or asset class. For example, you could choose a Japanese equity, global technology, government xed interest, UK corporate bond or North American smaller companies fund. As mutual funds tend to hold 60 or more stocks, they o er you more diversity than if you selected just one or two stocks from these markets. By selecting funds, you hand over the job of stock diver to the experts, leaving you to concentrate instead on the other main
- 4. CONTACT US FINALLY – BEWARE THE LATEST FASHIONS We hope you found the Today there are many more esoteric a higher-risk portfolio. In this way, they can aid investment choices than ever before, diver while featuring exposure to some information in this guide capturing the attention of potential investors exotic areas of the investment world. However, useful and informative. but also creating unpalatable risks if bought bought alone or as part of the core portfolio, alone. they would usually be considered too high a risk. If any of the points are of interest, or you Some of these products include debt obligations, The best way to start diversifying your portfolio, would like to discuss your own situation in gold, resources, Brazil, Russia, India and China blending together the myriad of options in a more detail, please call us on: as well as property products that invest in, way which is most suitable, is to speak to a for instance, developments in the Baltic and profession adviser. Not only can they o er vast Eastern European regions. Each of these may experience of the investment market but they 0207 831 4711 be a perfectly sound investment in the context in which they are sold, but will generally be can also advise on the most suitable structures and products for your investments to help much better suited to the satellite element of match your own circumstances. www.mplwealthmanagement.co.uk This guide is intended to provide information only and our understanding of legislation at the time of writing. Before you make any decision, we suggest you take professional advice. January 2011