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Investment diversification – sharemarkets

Investment assets

Investment diversification is a strategy that has well supported wealth accumulators for many decades. In normal circumstances, the various asset classes that constitute investment assets each work to a different cycle. When one asset class is performing well, another may be in decline and others either ‘bottoming out’ or on the incline. Whilst investment assets include Cash, Fixed Income (Bonds), Property, Equities and a range of ‘Alternatives’, this article is focused on equities. Equities (shares) are traded on the sharemarkets around the world and are considered the most liquid asset after Cash.

Adding assets with different economic and market cycles, blended in ratios appropriate to the investor’s timeframe and investment risk aversion profile is a usual investment diversification strategy.

Investment diversification within an asset class.

There are sound reasons for exercising portfolio investment diversification. They include taking advantage of the cycles mentioned above. There are also sound reasons for not relying on one segment of the market when selecting the assets for a portfolio. This holds particularly important in the Growth assets in the portfolio. (The ‘growth’ assets are categorised as those that have the capacity to grow in value as well as to provide an income. Growth assets include shares and property – and these two asset classes generally make up the majority of the growth portion of a portfolio.)

The equities portion of a balanced portfolio for instance, includes both domestic and global shares. This exposes the Australian investor to different economies, different capital structures, a broad range of industries – and some challenges around currency

Why do many Australians agonise over the volatility of the ASX?

Australian investors in particular, agonise over the performance of the Australian sharemarket. They are exposed to the results of any day’s trading on the ASX on a daily basis, both on the print and in electronic media. The following information relative to that market seems to be overlooked in their anguish:-

  • Australian equities represent less that 3% of the global equity markets;
  • Australian shares represent only about one-third of all investment assets in Australian portfolios (and it is less than 30% in self-managed super funds); and
  • the limited choices available to diversify even an entirely equities-based portfolio using Australian shares increases the ‘investment risk quotient’ of such a portfolio.

One of the concerns about the concentration on the Australian Stock Market is that very high concentration of companies in a very narrow range of industry sectors. The four ‘big Banks’ alone account for around 40% of the value of the top 200 companies in Australia. The two major mining (resources) companies account for almost another 10% of that sector. It is very difficult to achieve investment diversification with such a high concentration of value in so few companies. Hence, the ‘reach out’ for the more diversified equities opportunities in the international (global) markets.

What causes the volatility in sharemarkets?
…and which issues are of greater concern to you?

No doubt there is a strong list of contenders for the ‘event’ that will make you most nervous about investing in any event. Almost invariably, those headwind (downdraft) events that cause the most volatility in sharemarkets have provided buying opportunities for the medium- to long-term investor. There have been numerous studies that show that, historically –

  • markets always recover – and
  • the growth in the recovery phase is usually greater than the preceding fall in value.

Investors who have stayed focused on their investment strategy throughout the recovery from the GFC since its nadir in March 2009 have seen their portfolios recover almost all of their losses. Those investors have experienced occasional corrections of course, usually following short bursts of ‘irrational exuberance’ of investors pushing share prices high in too short a timeframe.

[Our firm periodically forecast our expectations for investment markets (including the Australian sharemarket).]

A quick pick list of events that could be causing anxiety amongst investors includes the following:-

  • Geopolitical: (in recent years there has been any number of areas to raise anxieties. These have included the Korean Peninsula, the Middle East region & Eastern Europe)
  • Natural Disasters: (including Australian fires, floods and cyclones; New Zealand and Japanese earthquakes; the US hurricanes and snow storms)
  • Economic indicators: (tardy European recovery, China ‘slow-down’, US debt, Commodity prices and Rising global population. Ageing demographics in western societies also contributes to this concern.);
  • Financial situations: (Rising corporate profits, Reducing unemployment, Increasing profit forecasts and Skills shortages in a number of developed economies); and
  • Contagion: in spite of the best efforts of company management, an impact on an industry sector (say Banking); or a region (say Greece), usually has a negative effect on all participants in that sector.

Geopolitical and natural disaster events are most likely to cause volatility on sharemarkets because of emotional over-reaction by investors. Economic indicators and financial realities of companies represented on the sharemarkets are more fundamental drivers of volatility. Of course contagion and some would say algorithms applied by computer software used by high frequency traders, exacerbate the volatility.

The fact that is overlooked by investors when they see the daily sharemarket report of reaction to these headlines, is that these events are usually there in one form or another – and the market usually recovers from them fairly quickly.

How should investors react to the opportunities that sharemarket volatility presents?

One issue that has been well generally accepted over the years is that the sharemarket is a relatively accurate forecaster of trends in the related economy: any predicted trend in the economy is usually reflected in the share market between five and nine months prior to the event. This is particularly evident in the United States where a high proportion of households own direct share portfolios.

Investors can consider market dips as potential buying opportunities, using corrections to achieve the diversification they seek in their investment strategy (particularly if the market has not been too optimistic in the first place). Share Traders will respond differently from Investors, probably reacting to events such as the above more tactically – and speedily.

A Continuum Financial Planners adviser can help optimise your sharemarket experience

The experienced advisers at Continuum Financial Planners Pty Ltd are well versed in investment diversification techniques: we advise a wide range of investors on their wealth management strategies and are available to engage with you to develop a plan to achieve as high level of financial independence as possible from your available and anticipated resources – ‘we listen, we understand; and we have solutions’ that we deliver through ‘personalised, professional wealth management advice’.

To ensure that your portfolio is properly constructed to your individual financial needs, goals and objectives, seek a meeting with one of our team – call 07-34213456, or use our Contact Us facility and be assured of prompt and courteous attention.

[This article was originally posted as part of the March 2011 eNewsletter: it has been updated and refreshed in May 2014, June 2016]

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