Skip to main content

Portfolio diversification is a time-tested method

At no time in recorded financial history has the benefit of portfolio diversification been so evident as today. The expression “don’t put all your eggs in one basket” is most apt for investing, and diversification is one of the most important principles to keep in mind when constructing an investment portfolio. We are in a truly global investment environment and the definition of portfolio diversification too is constantly changing. It used to be just equities, bonds and cash but over the last few years, partly due to increased risks as well as opportunities, the list now includes commodities, currency, art, foreign market investments and a host of other options which were once termed exotic or ‘alternative’.


An ideal diversified portfolio should contain different asset classes, investment styles, and mixed assets from different geographic regions. Studies have conclusively shown that a diversified portfolio of non-correlated investments reduces risk and improves overall return.
Your typical equity fund manager may have told you that you should diversify — but in different equity sectors such as infrastructure, telecom, pharma and so on. But as recent experience shows, investing in market sectors that tread in the same direction will not help much. I’m not saying that other assets’ prices haven’t fallen, but they don’t and they won’t move in tandem with equity prices.


Portfolio diversification can also be in terms of timing. Research has shown that individual asset classes perform well over a few years at best. Therefore, you could be investing in equities at one time and commodities the next. For example, many HNIs who exited equities in January this year, jumped on the commodity bandwagon for the next several months, making handsome profits. This particularly suited those who have a long-only fixation with markets. Since it’s not possible to predict which asset class will excel in any year, therefore diversification allows you to participate in the best-moving asset class of the time.

WHY COMMODITIES

Commodities have low to negative correlation to traditional asset classes like stocks and bonds which means that investment in commodities is a real portfolio diversifier leading to lower risk. International experience shows that while stocks and mutual funds are closely related to each other (since mutual funds typically invest in stocks anyway) and tend to have positive correlation with one another, commodities are a bet on inflation and have a low to negative correlation to other asset classes and are therefore a well-advised addition to almost every long-term investment portfolio.


As far as the financial nature of commodity futures markets are concerned, they are as much or as less risky as equity markets. International information flow, liquidity, long trading hours and an impossible-to-rig global market make commodities irresistible to fund managers of all hues. Long term commodity investors like the idea that prices can’t really decline beyond a point — much unlike equity, where the floor is virtually zero.


We feel that commodity investing is easier and more logical than other investment forms because commodity prices move due to actual or perceived demand/ supply factors and are therefore simpler to price rather than equities which have earnings, management quality and company cash flows as issues for pricing in which add to the ambiguity. For example, in the first quarter of 2009, steel prices rose but prices of steel companies fell due to sector re-rating in the face of a global slowdown. Knowing that steel prices were firming up, you would have made money if you took a long position in steel but lost pots of money if you took a long position in the very steel companies which were benefiting from the price rise!

INVESTMENT STYLES IN COMMODITIES

There are several investment options in commodity business. Typical long-only investors find comfort that buying and holding is just like equities — you can buy commodities and hold them in demat form till the time you sell.


Conservative investors may choose safe products like spot — futures arbitrage in which your broker buys a commodity for you from the ‘Mandi’ or spot market and simultaneously executes the second leg by selling the same commodity in the same quantity in the futures exchange locking in the profit. The returns work out best for agricultural commodities. Similarly, spread-trading is a popular strategy in commodities as is inter-exchange arbitrage. There are other exciting and novel ideas being floated such as buying gold, hedging it immediately and simultaneously using it as margin in commodity/equity trading, an idea whose time has come.


Commodity prices are falling today. So if there is no guarantee that prices will go up quickly, then where is the guarantee of returns? Aggressive investors know that commodities markets globally are futures based and you may be just as likely to short a commodity as long. For traditional investors, this comes as a paradigm change but the best fund managers and largest funds access commodity markets in this manner. This is also the reason why volumes in commodity futures exchanges remain firm even though prices have crashed. In other words, investors do not ignore chances for profit but depending on the mode of investment can be classified as either aggressive or conservative. Therefore aggressive investors may simply take futures positions and operate on both sides of the market — up and down.

So how does one diversify? The trick is to add asset classes with zero or negative correlation between them. Since most portfolios contain equity, bonds and cash, we need to add assets, which have no correlation with these.

Popular posts from this blog

ICICI Pru Mutual Fund Dividend

ICICI Prudential Mutual Fund has announced dividend under the following schemes: Scheme Dividend ( Rs /unit) ICICI Pru Capital Protection Oriented Ser V Plan B-D 0.03611325 ICICI Pru Capital Protection Oriented Ser V Plan B Direct-D 0.03611325 ICICI Pru Balanced Advantage Direct-DM 0.06 The record date has been fixed as February 08, 2017. ------------------------------ ------ Invest Rs 1,50,000 and Save Tax upto Rs 46,350 under Section 80C. Get Great Returns by Investing in Best Performing ELSS Funds Top 4 Tax Saver Mutual Funds for 2017 - 2018 Best 4 ELSS Mutual Funds to invest in India for 2017 1. DSP BlackRock Tax Saver Fund 2. Invesco India Tax Plan 3. Tata India Tax Savings Fund 4. BNP Paribas Long Term Equity Fund Invest in Best Performing 2017 Tax Saver Mutual Funds Online Invest Best Tax Saver Mutual Funds Online Download Top Tax Saver Mutual Funds  Application Forms For further information contact  SaveTaxGetRich on 94 8300 8300 ------------------------------ ------ Leave y...

What is Financial Freedom?

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India)     There were many things common between our Freedom fighters. All had the Single vision (Free India), common goal (independence) and had a disciplined and focused approach. They were ready to do anything and everything and had made so many sacrifices to see India free . But the road to freedom was not easy .They had faced lot many hardships, went to jail so many times and even confronted physical and mental torture from the British. There was one more thing which proved to be an advantage to our fighters that most of them were professional lawyers. The knowledge of legal issues and its impact on our country at large has helped them counter various bills and proposed new laws by the then government. It is due to their continuous effort that we are able to achieve the goal of Independent Indi...

Hidden Bank Fees

  What Banks Hide From Customers Imagine after a peaceful and exciting holiday you receive your bank statement with steep charges. You then rush to your bank and start confronting staff members and to your dismay, you come to know that the high end debit card was charged very heavily. Wouldn't this cause damage to your finances? So remember, the world outside is full of deceptive and double cheating people. Unethical practices are always used by company sales person in order to meet the target. Credit card companies, mutual funds and bank institutions always play dirty tricks to lure customers and the practices are rampant. So here's how you should be careful while dealing with your banks: High End Debit Card Charges While opening an account with a bank you opt for a debit card with minimal charges. But later on when you upgrade your card and opt for high end debit card the annual charge rise by a good amount. Though such a card has slew of features but it all comes at a high ...

Updating a minor PAN card upon becoming adults

  Updating a minor's PAN card once they become adults A PAN card issued in the name of a minor does not contain the minor's photograph or signature, and therefore, cannot be used as a valid proof of identity. Once a minor PAN card holder turns 18, the relevant changes must be made in the PAN records. A new card is then issued bearing a photograph and signature. Application The applicant is required to fill up the "Request for new PAN card andor changes or correction in PAN data" form. The form can be filled up online by accessing NSDL's Tax Information Network website and clicking on the online PAN application tab. Information The applicant must mention the existing PAN number in the application and check the `photo mismatch' and `signature mismatch' boxes, and submit the online form. The form must also be printed out, signed by the applicant, and submitted along with two photographs. Documents Identity and address proof in the form of a copy of the app...

Partial withdrawal from PPF

  Public Provident Fund (PPF) account has a lock in period   If you opened a PPF account to meet your retirement needs,, think twice about withdrawing from this fund before retirement. But provided it's an emergency here are the rules. Public Provident Fund (PPF) account has a lock in period before which you cannot withdraw your money.   The partial withdrawal is allowed after the completion of 6 financial years . This means that you will be allowed a partial withdrawal from 1 April 2017. The maximum partial withdrawal allowed is the least of the following: 50 percent of the account balance at the end of fourth financial year, 31 March 15 50 percent of the account balance of the end of previous financial year, 31 March 17.   There's a loan option available on your PPF account between the fourth and the sixth financial year. You can obtain a loan of up to 25 per cent of the balance in your account. However, this will attract interest of 2 percent more than the prevailing ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now