If you read the news or listen to the
radio you will invariably hear investment professionals talking about how
important it is to diversify. But what does this mean, why is this important
and how do you do it?
We all know the old adage that one
should not put all your eggs in one basket. Why? Because if you drop that
basket, all the eggs break. That’s diversification.
Diversification is important because,
at its core, it reduces risk. By spreading your investments, the chances of
picking a dud or having your entire investment wiped out are significantly
A diversified portfolio is like having
a whole team working for you on a tough task. If one part lags a bit, the rest
can pick up the pace and over time the journey to the goal will be a smoother
While you have a much better chance of
successful investing with the right process and skills on your side, the task
remains laden with uncertainty – after all we are dealing with future returns –
and the quality that a good diversification strategy brings should not be
underestimated. So how should you do it?
Start with the world
Recent events have
reminded us that even the most elite country’s “safe haven” status can be
questioned, and that a good spread of currency and economic exposure is
essential in building a robust long-term portfolio.
Limiting yourself geographically
will heighten the sensitivity of your portfolio to knocks that affect a part of
Be asset-class wise
Next, a major determinant of your
future returns (and the volatility along the way), will be your asset
allocation. The basic building blocks are equities, fixed income and cash, and
you should aim for an optimum mix which will provide enough growth (equities in
the long run) and enough stability and yield (cash and fixed income) to match
your time horizon and needs.
Tactical changes may be useful from time to time,
but a strategic long-term allocation goes a long way while it is left to do its
Tap into sectors
Within the equity portion of your portfolio, you should aim for a good spread
of industries. If you only invest in gold or only invest in property, this can
cause your concentration risk to go up significantly. This is where global
investing comes into its own.
There are several growth industries that we are
unable to invest in if we only invest locally.
Share specifics and credit partners
When it comes to equities, a minimum number of instruments and a maximum
percentage per instrument will help to diversify away from share-specific risk.
In the same vein, within the fixed income and cash portion there should be a
spread of banks and instruments.
If you only own a handful of
stocks, or are exposed to very few counter-parties, this will increase your
Sticking with one capable manager for the long term can be a very good
strategy. However, if the manager stays true to one style, it is likely that
there will be periods where the approach works better than at other times.
Therefore it is useful to combine managers with
different styles. For example, by combining a value manager with a momentum or
growth manager, or a passive solution with an active manager, can mean that
when a particular style is out of favour, your portfolio will not necessarily
languish in the doldrums.
The process of building a well-diversified
portfolio is best performed with a qualified and experienced financial adviser.
The reality of investing is that we are dealing with an assessment of an
uncertain future within an uncertain environment.
Diversification is one way to navigate this journey
so that your goals are met while better managing your risks.
Anet Ahern is CEO of PSG Asset Management.