The Power of Diversification

March 2016

The Power of Diversification

How often have you been at a social event and the conversation steers towards investments and everyone starts to share their most recent returns? The answer I have often heard is “my investment has done well”, which then deserves to be challenged as to what constitutes “well”. One needs a reference point to begin with as there strategy, but believe they should have oneas that’s what people with a lot of money are told and sold!

Is a fundamental part of the question that is not being answered, and that is to quantify how your performance has stacked up to its peers, the market in general and most importantly how well it has done given the amount of risk you are taking as an investor.

Once again a recent client reminded me of this so I thought it might be helpful to share some of the thinking with regards to diversification. The client was almost exclusively invested in local equities through a managed share portfolio, which they believe had done well. So our immediate concern at Harbour Advisory was that this client was basically ‘all in’ on one asset class in one geography and the most volatile one at that. We are passionate believers in the importance of diversification in investing. There is a lot of research out there to suggest that asset allocation is the primary driver of portfolio returns (Singer and Beebower’s research calculated it at 91%) yet here was a client trying to beat the odds that were clearly stacked against him. Many clients do not understand the role of share portfolios in an investment.

At Harbour Advisory we like to deal in facts and so we went to look at Funds Data online to try and prove the importance of diversification. We pulled up the best performing Funds over 3 years for the South African Equity General category and the Global Equity General and what we were able to prove was astounding.

If you had chosen the #1 performing fund in SA equity you would have achieved an impressive return of 16.62% annualised over the period, you would have done “well” and rightfully been happy with that. But, in the Global Equity category that would have put you in a paltry 35th place out of 37 in terms of performance. You could have thrown a dart at the list of Global Equity Funds and done better, way better in fact. The #1 Global equity has returned an annualised 29.18% (ZAR) return over the same period, now you ask how “well” the first return was when put into that perspective.

This example displays the importance of diversifying between local and offshore investing. Consensus for some time was that the Rand was overvalued, so Harbour Advisory has been overweight offshore, this call hasresulted in superior portfolio returns for clients in tough times.

We then looked at another asset class which revealed a similar pattern. We pulled Funds Data on the South African Real Estate General (Listed Property) over 3 years and the results were similar. The top real estate fund generated a return of 23.99% versus the 16.62% of the SA General Equity, in fact even the 24th best Property Fund would still have put you in the top bandof Equity Funds.

If you look at asset class returns over anything from 3 to 40 years you will see that of the growth assets, Listed Property actually has outperformed SA Equities. Most asset managers have been underweight property while we at Harbour have been full weight. It confounds us why, given the facts so many investors including asset managers continue to shun property as an asset class.

I will leave you with a quote from a quality piece of research from Deanne Gordon at SBG Securities that she released recently titled “SA asset class performance, a long term history”, this encapsulates precisely our view at Harbour Advisory.

“Every investor holds a portfolio of assets and has an investment time horizon. The primary and most important decision is the allocation of assets given the selected time horizon and taking into account the investors competing requirements regarding returns and risk. Risk diversification, through both correct asset allocation and time diversification, is crucial”.

On a separate note I thought I would share a piece of research that made me almost fall off my chair. I thought it would be prudent to share it with our clients as we go through this timeof heightened volatility and angst in the markets as investors begin to nervously question their investments as returns stagnate from the lofty levels of recent years cialis comparatif.

Peter Lynch ran the Fidelity Magellan Fund from 1977 – 1990 delivering an incredible 29% (USD) average annual return over the period. Fidelity then wanted to understand the numbers better on an individual client basis. They measured returns from when each investor invested to when they withdrew their funds. When the number crunchers came back with the results they had tosend them back to double check them, sure enough they came back with the same result and guess what that was? The average investor had LOST money during this incredible 13 year run, how could that be? Fidelity’s own research into the matter showed that most investors would head for the hills when the fund underperformed and then would come rushing back in when the fund had a successful run. This behaviour in our industry is called performance chasing and it crushes many hopes of wealth creation, it needs to be avoided at all costs.

So in these trying times, ensure you and your Wealth Planner have sat down and drafted your investment strategy. They will ensure the asset allocation for you is right, they will assist you in putting the plan in place taking into account your time horizon. Then most importantly, they will help you stick to the plan and encourage you to add to your investments wherever you possibly can.

‘ARE YOU WONDERING HOW THIS BUSINESS LEADER LEADS SUCH A STRESS FREE LIFE?

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1 thought on “The Power of Diversification

  1. Andy Greenwave - April 6, 2016

    Very good article Marc! Just shows how naive we can be when making a ‘call’ or trying to ‘time’ an investment. Asset allocation and knowing your investment time horizon sounds like the true key to me.

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