BT: Diversify to absorb shocks (20 Sep 2008)

Diversify to absorb shocks

Regular, diversified investing over long term is best for retirement portfolio, says Genevieve Cua

FROM the scale of deleveraging that has unfolded in the past few weeks, it would seem that no asset class has been spared. Equities in particular, a staple in a retirement portfolio, have suffered a mauling more severe than in any other recent crisis. What does this mean for your retirement portfolio? Should you take a vastly difference stance towards asset allocation? After all, correlations have clearly and distressingly shot up, obviating any diversification benefit you previously may have reaped through your asset combination.

Experts say it's time to get back to basics. That may sound boring, but it works - that is, if you have the discipline to keep investing and not let short-term losses and fear derail your plan. Says Russell Investments director Lim Meng Tat: 'Markets are telling people to get back to fundamentals. If you look at the basic asset classes, they are all under-priced and are at very attractive levels now. Nothing changes in what we tell people - they should diversify across asset classes. Portfolios will suffer because valuations are down, but it is the right approach. Markets will come back at some point.'

Certainly, those who maintain diversified portfolios would have suffered relatively less than those who have concentrated holdings. In the year to date, for example, based on Morningstar data, numerous funds in the Asia ex-Japan equity sector and former market darlings such as BRIC, global emerging markets and China and India funds have plunged 45 to 50-plus per cent. BRIC refers to the grouping of the equity markets of Brazil, Russia India and China.

In contrast, global bond funds are a relative oasis. Returns are negative but by a mild single-digit loss. Global balanced funds have also suffered losses, but relatively milder than all-equity funds. Depending on the equity exposure, the steepest loss is over 20 per cent.

But it's not too late to do some damage control. Now is as good a time as any to revisit your strategic asset allocation and rebalance some positions. Here are some basic principles that have proved to be evergreen.


Think asset allocation

This means taking a portfolio approach to your investments, picking assets that offer diversification benefits. Bonds, for example, tend to to outperform in a bear market and should provide stability even though returns are staid.


Think long term

Says Christopher Tan of Providend: 'If you have a horizon of 10-15 years, there is nothing to worry about. There is data showing there will be certain points when stocks and bonds go up and down together. But over a longer period, diversification still works.'

Data from Morningstar shows that while the one-year return from broad asset classes is now down about 5 per cent for global bonds and up to 45 per cent for China equities, the longer-term returns of three to five years remain decidedly positive.

US-based Ned Davis, which looked at long-term market returns, has found that over 80 years between 1926 and 2006, 88 per cent of the five-year periods and 97 per cent of 10-year periods yielded positive returns. Over 20-year periods, returns have been positive 100 per cent of the time.


Beware leverage

Leverage magnifies returns in a bull market but deepens losses in a downturn. In the current market, investing with borrowed money risks the dreaded margin call, which forces you to sell other more profitable assets, or worse, sell your losing position at a time when poor liquidity could force you to lower your asking price.


Beware structured products

Structured products should not be seen as part of your strategic asset allocation. They have no place in a retirement portfolio. This is because a structured product typically forces you to take a tactical view of markets, even though it may tie you down to a long holding period. Structured products are also typically complex and fees are not transparent.

If you must invest in one, do so only at the margin. Clients of banks who have bought into structures linked to Lehman are likely to have to write off such investments completely. The truth is that the only party to benefit all the time from the structure is the distributor who collects fees and the issuer who claims on the assets when a credit event or bankruptcy occurs.


Invest regularly

This cannot be emphasised enough - particularly for young investors, for whom a long time horizon unleashes the power of compounding. Compounding over long periods turns a modest sum into a tidy nest egg. For example: $500 invested quarterly over 20 years at 8 per cent per annum will grow to almost $100,000.

Regularly investing in a balanced portfolio also enables you to 'dollar cost average', putting more into the market when prices are down.


Look for assets with a steady income stream

These will cushion occasional falls in value. For clients who are saving for retirement, New Independent's Joseph Chong puts together a 'synthetic annuity' that is a portfolio of income-yielding assets. These may include property and government bonds. A conservative portfolio is likely to be down about 12 per cent, and an aggressive one more than 20 per cent, he says. 'Our portfolios's average PE is about 9.5 times. With a two-year outlook, it will rebound easily.'


Rebalance now and then

ipac adviser Roy Varghese says that he has been evaluating clients's portfolios and advising them to trim higher-risk holdings. 'Our long term strategy remains the same, but for some clients, I have asked them to consider moving into globally diversified portfolios.'

Large positions in China and India could wreak deep damage. Assets that have dropped 50 per cent will need to rise 100 per cent to get back to previous values.


Focus on objective, not on emotions

Avoid checking stock or fund prices too frequently. Investors are often their own worst enemy. Fear and greed drive irrational behaviour, leading people to sell low and buy high.

gen@sph.com.sg

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