The benefits of diversification
Diversification in Asia Pacific
There have been few investment strategies which have been able to escape the current economic downturn and negative returns. Whether investors have concentrated portfolios or aimed for diversity to mitigate risk over the long term, some are not seeing past the short term losses faced. As a result investors are questioning whether diversification is the answer to protecting and growing their assets.
For sophisticated investors, many still believe that diversification, while also performing poorly in recent times, has somewhat shielded them from the extremes losses of an “all eggs in one basket” investment approach. FTSE is involved with the world’s largest asset owners investing in sophisticated and mature markets across Europe, The Americas and Asia Pacific who run diversified portfolios. In the Asia Pacific region specifically, we see a wide range in the maturity levels of markets and asset owner sophistication. Emerging markets such as China, Malaysia and Taiwan are studying the asset allocation models in the developed markets of Australia, Japan and Singapore. After taking quite a hit on concentrated investment, especially in China, they are looking at various strategies to help them diversify their portfolios for the long term.
Diversification and the alternative
Let’s study how diversified portfolios can benefit investors and why there is continues to be a case for this approach. By taking a concentrated approach to investment for long term asset protection and growth, investors are increasing the risk associated with single-minded strategies when performance patterns and investment cycles vary across different asset classes. A well diversified portfolio instead tends to spread risk by investing into vehicles with low correlations such as equities and real estate. Studies show that this imperfect correlation will result in better performance over a long term investment horizon.
The growth of satellite strategies
Australian-based asset owners have set the trend in the region and generally been advocates for diversification. With large pools of assets growing with expansive pension schemes, there is the ability to test various strategies. Many of the large funds have set up core plus satellite strategies, which work hand-in-hand to spread funds into a number of asset classes.
Satellite strategies can be quite varied, including investment into real estate, hedge funds, infrastructure, debt and commodities. While many of these have been under scrutiny with Australian investors avoiding some, there is still a strong case for investing into real estate for example, with several new global mandates being issued recently by Australian superannuation funds against the FTSE EPRA/NAREIT Global Real Estate Index Series. Real estate has a low correlation with equities and has always been a popular choice for diversification in Australia, either as a way to increase market capacity on shore or to expand this strategy to global real estate assets.
Weighting your portfolio
Satellite strategies are the key to diversification but there are also other ways to look at the core portfolio to achieve long term performance gains or loss protection. One approach is to review the equities weightings within a passive portfolio. Passive portfolios tend to be market cap weighted and are affected by speculation and market anomalies. By weighting a portfolio differently, for example based on fundamental factors as in the FTSE RAFI approach, or wealth weights as in the FTSE GWA Index Series, asset owners are finding these indices as an effective tool to manage portfolios and achieve diversity while buying the same or similar stocks in different weightings. Many asset owners are moving into non market cap weighted strategies across Asia, with Australia and Japan leading the way.
The need for transparency and the role of indices
Besides the question of diversification, there is a growing need to move towards greater transparency and increased simplicity, especially in understanding the base of underlying assets which the portfolio is constructed on. In these tough times, fees are also being questioned with active managers finding it increasingly difficult to beat the benchmark. As a result, passively managed investments are increasing in popularity. This combined with the broad range of indices covering a broad range of asset classes including equities, alternatives and fixed income are driving investors towards alternative index strategies as a way to manage their risk or put risk management into play.
Paul Hoff
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