Why diversification is a good investment strategy

The last few weeks and months have seen an increase in volatility and uncertainty in financial markets due to macro-economic events and it is likely that there will be further economic turbulence in the coming months. These in return could have an impact on your personal investments and/or pension arrangements and with that in mind, now may be a good time to talk to us. We can assist you in diversifying your investment portfolio.

Apart from the ongoing Greek crisis, other global factors that are coming into play include: volatility in the Chinese stock market and the potential impact of a US interest rate increase.

The Chinese stock market has been booming until recently with the Shanghai market up almost double in the last year. The primary catalyst has been government-led initiatives to open up the Chinese financial market and the encouragement of more retail investors to participate in the stock market.

Questions are being asked whether the market is now in bubble territory with company shares on the domestic Shanghai exchange trading at close to 19 times the price/earnings ratio. The worry for global markets is that any sharp or prolonged correction in the Chinese market could lead to global contagion.

Bonds 

While long-dated Government bonds are normally viewed as a relatively low risk asset class they are now in bubble territory and with the outlook for an increase in interest rates towards the end of 2015 and early 2016 this could lead to the risk of significant losses for any funds exposed to long-dated bonds.

The potential for a US Interest rate hike in September has resulted in close to a 10% correction in bond funds and if interest rates rise as expected, it could have a detrimental impact on the performance of many pensions and fixed income investments. The size of that impact is unclear, but to prepare for a more challenging time ahead clients should diversify.

Diversification

And that's the point of allocating monies across different asset classes. The approach may not provide the best returns, when compared to equities, but it covers the risks associated with the economic conditions of deflation, inflation and recession.

Equities have, over the long-term, delivered returns of circa 3-4% per annum in excess of returns from bank deposits (or their equivalent short-dated treasuries), gold and even long-dated bonds. Alternative assets classes worthy of consideration include forestry, property, gold, infrastructure – asset classes which can provide long-term returns with reduced volatility.

Diversification is the cornerstone of successful investing. Many of the world’s leading sovereign wealth, pension and endowment funds use a range of different investments that combine a number of assets which are lowly correlated with bonds to smooth investment returns over time. This multi-asset approach to investing can help lower the volatility of returns over time, and help offset some of the weakness in a rising interest rate environment.

Summary

In relation to the impact on financial markets, the one thing we do know is that investors do not like uncertainty. Financial markets are likely to remain under pressure and market volatility will remain.

Now might be the right time to review your personal and/or pension portfolio. If you wish to do so, please do not hesitate to contact your IMO FS financial adviser directly or the office on 01/6618299 and we will be happy to provide advice.

Our Financial Advisory Team

Ronan McGrath         rmgrath@imo.ie            086 1724411

Francis McGrath        fmcgrath@imo.ie          086 3852484

Daragh Turley            dturley@imo.ie             086 8113023                             

Warning:

Past performance is not a reliable guide to future performance.

The material is not intended to provide advice is provided for general information purposes only.