* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download Asset Allocation and Diversification
Private equity wikipedia , lookup
Present value wikipedia , lookup
Financialization wikipedia , lookup
International investment agreement wikipedia , lookup
Rate of return wikipedia , lookup
Securitization wikipedia , lookup
Early history of private equity wikipedia , lookup
Systemic risk wikipedia , lookup
Negative gearing wikipedia , lookup
Business valuation wikipedia , lookup
Beta (finance) wikipedia , lookup
Stock selection criterion wikipedia , lookup
Land banking wikipedia , lookup
Global saving glut wikipedia , lookup
Financial economics wikipedia , lookup
Modified Dietz method wikipedia , lookup
Harry Markowitz wikipedia , lookup
Investment fund wikipedia , lookup
Asset Allocation and Diversification Aim to get the right eggs in the right baskets. Asset Allocation is a term that describes how much money you have invested in each of the main investment asset classes; Cash and Fixed Income/ Interest, Property and Shares/Equities. How you decide to split your investments between these categories will determine your future returns, and more importantly, the level of risk you will face. The spread across these different asset classes (your asset allocation) will vary depending on your risk profile. For example: if you are a conservative investor and don’t want to take a lot of risk, your portfolio would contain a larger percentage of cash and fixed interest and less shares/equities. In New Zealand, our most popular investments are our house, business and term deposits, and we tend to have a great deal of our total wealth tied up in these few assets. Investors who don’t want to take excessive risk by “putting all their eggs in one basket” however need to diversify their investments. Diversification by Sector Diversification is all about reducing risk by investing in different areas and investment options. This approach is necessary if you are serious about protecting your longterm financial situation. For example, within shares, an investor will usually hold securities within a number of different companies and sectors. If you want your investment to produce a reasonable income as well as grow and be protected from inflation, you must make diversification a foundation of your investment strategy. The below charts show how a portfolio may be diversified across asset classes, sectors as well as geographies. Diversification by Asset Class The first, and most important way to break down your portfolio is by asset class; • Cash • Fixed Income/Interest • Property • Shares/Equities Diversification by: Asset Class Diversification by: Sector It is standard investment practice to spread risk by diversifying your investments across different assets as well as across a number of investments within each asset class. If one sector is performing poorly, other well performing sectors can generate income for your portfolio and thereby promote more stable returns. It is important to be aware that industries are influenced differently by external factors. The building industry for example is largely influenced by the general economy. If the economy is in decline, perhaps even in recession, there will be no demand for new houses and construction companies will be impacted. Since the company would be performing poorly the value of the company would fall including the share price. Companies within infrastructure rely on government spending and if the government decides to divert money from infrastructure, these companies will be affected negatively. Sector Infrastructure Examples of companies in each sector Auckland International Airport Diversification by: Geography Transportation Mainfreight Fixed Interest Property Shares/ Equities Port Port of Tauranga Healthcare Fisher & Paykel Healthcare Ryman Healthcare Energy Meridian Energy Property Kiwi Income Property * Above sectors are companies listed on the NZX as at 31.08.14 Australia NZ Em M ar erging ke t s Cash Global These proportions are for example only and does not reflect appropriate or recommended asset allocation. 1 Due to the differences between sectors, it is important to diversify your portfolio to manage the risks within each of the sectors. Diversification by geography is also important in order manage risk and mitigate the impact of poorly performing markets, whilst taking advantage of better performing markets. Whilst one country may be in decline, another might be enjoying growth and this can help provide positive returns. Diversification by Geography Certain sectors may be stronger in some countries than others, and therefore it is important to look at, not only what sectors to invest in, but also where. Who will do better? The Question Who will do better, Investor A who achieves a 10% return every year for three years or Investor B, who enjoys two years of 100% returns and then one year of negative 68%? 45000 40000 The Answer 35000 30000 $ Amount example, this may require you to invest in Australian and global shares. This is because most banks operating in New Zealand are Australian owned and listed on the Australian Exchange. Therefore, by investing overseas you will get exposure to a different economy and sectors, which may not be available locally. A poor performing economy may impact retail sales whilst commodity prices will remain steady or perhaps even increase. This is because commodities are not as influenced by general demand. Even if the economy is poor, we will still need petrol (crude oil) for our car. 25000 Investor A $13,310 20000 15000 10000 The below chart shows an alternative way in which a diversified portfolio may be structured across different asset classes, sectors and geographies. In New Zealand we have a strong primary and energy sector, but to gain exposure to the banking sector for Investor B $12,800 5000 0 1 2 Year 3 Source: Craigs Investment Partners, September 2014 4 $10,000 invested for three years at 10% will grow to $13,310. The same amount will grow to $40,000 after two years of 100% returns, but will then drop to just $12,800 after the third year’s loss of 68%. The Lesson Slow, steady returns beat fast, volatile returns over the long-haul- another example demonstrating the importance of a diversified portfolio. A Diversified Investment Portfolio Asset Class Cash Fixed income Company Financial Genesis Geography Shares What ever you do - diversify! Energy Sector Property NZ Commercial Kiwi Income Property Westpac AUS Residential Stockland NZ AUS Healthcare Energy Infrastructure Fisher & Paykel Healthcare CSL Meridian Energy Santos Auckland Airport Sydney Airport NZ AUS NZ AUS NZ AUS The future performance of markets is uncertain and risks that could potentially threaten the value of an investment portfolio are unforeseeable. Diversification helps protect investors against this uncertainty. Risk comes in many forms and history has shown time and again that a diversified investment portfolio is the best protection against risk, wherever it comes from. Relative Return From Key Investment Assets (NZD) September 1998 - June 2014 As the graph shows, markets can be volatile due to many reasons and performance can vary by wide margins, both over the short-term and also over longer time periods. The balanced (diversified) portfolio (in red) has not achieved as high returns as Australian or New Zealand shares but has remained relatively stable in comparison. This illustrates the importance of diversification. 5000 NZSX All Gross Index 10.02%pa 4500 4000 3500 Australian All Ords 8.40%pa 3000 Craigs Balanced Portfolio 7.57%pa World Share Prices (USD) 6.31%pa 2500 NZ House Prices 6.27%pa 2000 Wholesale Interest Rates (90 day) 3.71%pa 1500 World Share Prices 2.60%pa Inflation 2.25%pa 1000 500 0 Sep-98 Mar-00 NZSX All Gross Sep-01 Mar-03 MSCI World Gross (NZD) Sep-04 90 Day Bank Bill Mar-06 Sep-07 REINZ NZ Avg House Price Mar-09 Inflation Sep-10 Mar-12 Aust All Ords (NZD) Sep-13 Craigs Balanced PF MSCI World (USD) Note: The NZSX All Gross Index is a gross index and from 1 October 2005 assumes the reinvestment of cash dividends. Prior to this date, the NZX gross indices assumed the reinvestment of gross dividends (ie including imputation credits). The Australian All Ords Index is an accumulation (or gross) index and assumes he reinvestment of cash dividends. The Craigs Balanced Portfolio is included as an example of a diversified portfolio. The MSCI World Gross Index is a gross index and assumes the reinvestment of cash dividends (ie it does not include tax credits). The NZ house price return shown above does not include any income that may have been derived from owning such property. It is purely a measure of capital return. The Wholesale Interest Rate return is after tax (now 30%). 2 Asset Allocation and Diversification – 09/14 3 8 Reasons why we should diversify our portfolios 1. ecause diversification is the only free lunch in B the investment world. Sophisticated investors know that a high proportion of speculators fail (we hear only of the very few who strike it lucky) and they know that the only free lunch in investing is diversification. It reduces risk significantly without sacrificing much from returns. Nothing else in investing comes close to offering as much “bang-for-your-buck”. 2. B ecause nothing is certain in the investment world. There are no facts in investing; only forecasts, historical data, theories and judgement. Nobody knows how our economy will perform in future, what markets will deliver the best or worst returns, what inflation will do, or in what direction interest rates will move. The only way to protect against this uncertainty is diversification across a range of assets, markets, sectors and securities. Diversification can be viewed as an insurance policy against uncertainty. 3. B ecause the extra return you might earn from concentrating your portfolio is not worth the risk. In the past, over the long term, shares have returned about 10% a year, property 9%, fixed income 6% and cash 4%. A balanced portfolio has typically returned an average return of 7% to 8% a year, which is only marginally less than a portfolio concentrated in shares or property, with far less risk. 4. B ecause the lower return you receive from not investing can leave your capital exposed to inflation. Many people shun diversification into shares and property altogether and prefer to keep all their savings in term deposits. This feels safer, but such a portfolio will probably earn 2% to 3% a year less than a balanced portfolio. That doesn’t sound like much, but that’s about the annual rate of inflation, and inflation can erode the spending power of your savings over time. 5. B ecause market timing is very important, but very difficult. The price you pay for shares, property, bonds and currencies has a big impact on your future returns. As the saying goes, it is better to ‘buy low and sell high’. However, trying to pick the best time to invest is very difficult because the future performance of markets is unpredictable. We therefore believe it is absolutely crucial that clients not only diversify their investments but also diversify their market timing by purchasing their investments in instalments over a period of time. 6. B ecause risk comes in many guises. Risks are by definition ‘unforeseeable’, and are also unquantifiable. Some examples of risks that portfolios need to be protected against include a sharp increase in inflation, a period of Japanesestyle deflation, extreme stock market volatility, a collapse in house prices, credit risk and corporate failures, dramatic currency movements, a significant shift in interest rates either up or down, a lack of liquidity and inability to exit investments, asset bubbles and changes to government or government policy. Diversification is the first line of defence against risks such as these together with the myriad of other risks that face investors. 7. B ecause most investment disasters are caused by a lack of diversification. When you look at instances where investors have suffered catastrophic and permanent capital loss, perhaps two-thirds or more of their life savings, a lack of diversification is almost always a contributing factor. 8. B ecause diversification doesn’t mean buying a ‘rent-a-crowd’ portfolio. There is no need to consider sub-standard investments simply because they enhance diversity. Stick to quality for core holdings and only buy investments that meet your quality and income requirements – just aim to own as many of those as you can. This is general information only. The examples are provided as an illustration and are not intended to represent any indication of future performance. Investments are subject to risks and their value can go down as well as up. Before making any investment decisions we recommend you seek professional advice. While this information is considered reliable its accuracy and completeness cannot be guaranteed QuayStreet Asset Management Limited, its related companies and their respective directors and employees do not accept liability for the results of any actions taken or not taken upon the basis of this information or for any negligent mis-statements, errors or omissions. 4 Asset Allocation and Diversification – 09/14