Topic 7: Asset allocation and diversification

Transcription

1 Topic 7: Asset allocation and diversification Determining what proportion of a portfolio should be invested into each asset class cash, term deposits and fixed income (commonly referred to as income assets) and property and shares (commonly referred to as growth assets) is referred to as asset allocation. 26 \ CRAIGS INVESTMENT PARTNERS

2 Deciding on an appropriate asset allocation is a very important step in portfolio management as how a portfolio is split between the asset classes determines, more than any other factor, a portfolio s risk and return profile. As such, the composition of a portfolio between income (fixed interest) and growth assets (shares) will depend on an individual s objectives and risk tolerances. The rationale behind diversification comes from the old saying about not putting all your eggs in one basket. If you don t want to place 100% of your capital into one investment, diversification provides peace of mind that if one or two of your investments are performing poorly, you have others which may do better to provide a return. As well as helping protect your capital, diversification should also help smooth the returns you receive. A portfolio that consists of one share only, will likely have returns that jump around wildly, while a portfolio that holds cash, fixed interest, a range of shares and some listed property will have a more reliable, less volatile return. Diversification by asset class Fixed income Cash Property Shares / Equities 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. Investor Basics Overview of Investing / 27

3 Diversification by sector Utilities Telecommunication Services Information Technology Real Estate Financials Healthcare INFORMATION TECHNOLOGY ENERGY FINANCIALS CONSUMER STAPLES * This chart is illustrative only Energy Materials Industrials Consumer Discretionary Consumer Staples HEALTHCARE If only looking at shares/equities, it is important to diversify by investing in different sectors, for example, building/construction, transport, energy etc. so that if one sector is performing poorly, other well performing sectors can generate income for your portfolio. Certain sectors may be stronger in some countries than others, and therefore it is essential to look at, not only what sectors to invest in, but also where. 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. Due to the differences between sectors, it is important to diversify your portfolio to manage the risks within each of the sectors. 28 \ CRAIGS INVESTMENT PARTNERS

4 It is important to diversify holdings across sectors Key Sector Sub sector Examples Energy Materials Industrials Consumer Discretionary Consumer Staples Healthcare Financials Real Estate Information Technology Telecommunication Services Utilities Energy equipment & services Oil, gas & consumable fuels Chemicals Construction materials Containers & packaging Metals & mining Paper & forest products Capital goods Commercial & professional services Transportation Automobiles & components Consumer durables & apparel Consumer services Media Retailing Food & staples retailing Food, beverage & tobacco Household & personal products Healthcare equipment & services Pharmaceuticals, biotechnology & life sciences Banks Diversified financials Insurance Residential, retail, industrial and diversified REITS Real estate management & development Software & services Technology hardware & equipment Semiconductors & semiconductor equipment Diversified telecommunication services Wireless telecommunication services Electric, gas, multi and water utilities Independent power and renewable electricity producers Schlumberger, BP, Z Energy, APA Group Fletcher Building, Amcor, BHP, 3M United Technologies, Auckland Airport, Mainfreight, Port of Tauranga, Sydney Airport, Kirby The Warehouse, Seek, Sky TV Woolworths, Wesfarmers, Diageo, Unilever F&P Healthcare, Ryman Healthcare, Cerner, CVS Health, Ramsay Health Care, Reckitt Benckiser, Johnson & Johnson, CSL Wells Fargo, Commonwealth Bank, Medibank Stride Property, Vital Healthcare, Westfield Visa, Alphabet, Apple Chorus, Telstra, Spark, Vodafone AGL Energy, Meridan, Southern Company, ishares Utilites ETF * Above sectors are companies listed on the NZX as at December Investor Basics Overview of Investing / 29

5 Diversify by geography * This chart is illustrative only Diversification by geography New Zealand Emerging Markets Australia Global Certain sectors may be stronger in some countries than others, and therefore it is important to look at not only what sectors to invest, but where. In New Zealand for example, we have a strong agricultural sector and utilities sector, but to gain exposure to the banking or financial sector, you may have to invest in Australian or other global shares. In addition to the strength of certain sectors in different parts of the world, economies grow and slow at different times, so spreading some of your investment abroad can be important to avoid exposing your investment risk to just one market. That is the simplistic view. You then need to thoroughly research the best stocks within each of those sectors and geographies. The shares or fixed interest you chose will differ depending on your appetite for risk, and your personal financial goals. 30 \ CRAIGS INVESTMENT PARTNERS

6 Relative return from key investment assets (NZD) September February 2016 KEY: NZSX All Gross MSCI World Gross (NZD) 90 Day Bank Bill REINZ NZ Avg House Price Inflation Aust All Ords (NZD) Craigs Balanced PF 5650 NZSX All Gross Index 10.29%pa 4650 Australian All Ords 7.54%pa 3650 Craigs Balanced Portfolio 7.74%pa NZ House Prices 5.97%pa World Share Prices 3.55%pa Wholesale Interest Rates (90 day) 3.57%pa Inflation 2.06%pa 650 Sep-98 Mar-00 Sep-01 Mar-03 Sep-04 Mar-06 Sep-07 Mar-09 Sep-10 Mar-12 Sep-13 Mar 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 (i.e. including imputation credits). The Australian All Ords Index is an accumulation (or gross) index and assumes the reinvestment of cash dividends. The MSCI World Gross Index is a gross index and assumes the reinvestment of cash dividends (i.e. 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%). As the graph above 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. Whatever you do - diversify! 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. Therefore investors should ensure portfolios are diversified by asset class, sector and geography. Investor Basics Overview of Investing / 31