| Diversify to minimise loss and create long term wealth |
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 Varying your exposure to different asset classes is crucial to long term wealth creation. Not only does this strategy help to grow your portfolio it also protects against severe losses, which can be difficult to make up, says Marius Fenwick of Mazars Moores Rowland Financial Services.
“Our clients know the detrimental effect of losses on their long term investment goals, so our mandate is to protect their capital while generating inflation beating returns. We achieve this by actively managing the asset allocation in our portfolios, resulting in much less volatility and minimising downside risk,” says Fenwick.
Not only are losses difficult to recover from, he says, they can also trigger panic and result in investors making poor decisions based on knee-jerk reactions and seriously undermining their long term financial well being.
Fenwick says market conditions change rapidly, so it’s important to constantly monitor your portfolio. Too many investors fled from equities when the bull market cooled and put all of their savings into cash and money market funds. Unfortunately this was done after the fact with losses already incurred and by moving to cash the losses were realised. And this trend is continuing. According to the Association for Savings and Investments SA (ASISA), the bulk of investors’ money remains exposed to fixed interest investments, despite the fact that five year, pre-tax performance statistics to the end of June this year show that the domestic general equity sector returned 18% a year, double the 9% returned by money market funds.
Fenwick says some investors try to time the market, putting all their portfolio in to cash when equities are retreating and all of it into equities when the market is running. “But timing the market is extremely difficult even for the experts,” he says.
Adjusting your asset allocation in keeping with interest rate and economic cycles is the solution, Fenwick says.
“Different asset classes react differently during the various economic and interest rate cycles. Generally there is always an asset class or two that provides positive returns irrespective of the cycles. The idea is not to move all your assets to the asset classes that are expected to provide the positive returns but to merely tilt the portfolio to favour those asset classes that are expected to perform and most certainly reduce exposure to asset classes that are expected to lose value due to over valuations. Unfortunately the theory does not always actualise in reality as markets and investment prices are determined by demand and investment demand is directly related to investor sentiment which is unpredictable. This is the main reason why a portfolio should always be exposed to all the asset classes (in varying degrees) at all times,” says Fenwick.
To illustrate the power of diversification, Fenwick did a simple exercise, looking at the returns generated from an initial investment of R100 into an equity-bias portfolio, and the same investment into a cash-bias portfolio from 1st January 2005 to 1st January 2009, varying the split between equities and the money market according to market conditions. All cash holdings were taxed at 30%.
For the first two years, (January 2005 to January 2007), 70% of the equity-bias portfolio was invested in the ALSI and 30% was invested in the money market. Then, from January 2007 to January 2009 30% was invested in ALSI and 70% in money market; and finally from January 2009 to July 2009 70% was invested back in the ALSI and 30% back in money market. This portfolio generated a total return of R193 on the initial R100 investment.
From January 2005 to January 2007 the cash-bias portfolio 30% was invested in ALSI and 70% in the money market. From January 2007 to January 2009 100% of portfolio was invested in money market; and from January 2009 to July 2009 30% was invested back in the ALSI and 70% back in money market. This portfolio generated a total return of R173.
Over the four-year period, simply investing in the ALSI would have generated a total return of R194, but with much greater volatility, which can create a real problem if investors are at retirement age and need to purchase a pension at exactly the time when the ALSI is underperforming.
Fenwick did the example only using cash and equities because many investors tend to either put their money in the market, or in cash. No strategic asset allocation was done in this example. By adding other asset classes and specific funds (not the ALSI as in the example) and by changing the asset allocation more actively, the out performance of the managed portfolio is drastic.
In conclusion, Fenwick says the current market where interest rates are probably at the bottom and dividends on preference shares have reduced as a result, is an excellent time for investors to realise the importance of diversifying their investments across different asset classes. |
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Posted by joseph on 11 Dec 2009
