Throughout my time as a financial investor, and working with investments, there was on theme that was constantly repeated, and that is ‘diversification’. A very successful hedge fund manager by the name of Jack Meyer, is quoted as saying
The most powerful tool an investor has working for him or her is diversification. True diversification allows you to build portfolios with higher returns for the same risk.
My objective in this article is to demonstrate an investment strategy that attempts to diversify across all sectors and geographic locations. The idea is to invest in global growth and inflation. Whilst different sectors and countries grow or shrink at different times, overall global growth and inflation is much more stable and reliable thing to predict over the long term. The world is constantly innovating, becoming more efficient, and moving citizens out of poverty into the middle classes.
It is common for investors to choose assets from their own country, or countries they know well. For example, only buying British and American shares, due to the familiarity of the countries and its products/services. The problem with this is that it is reliant on those nations being profitable, and all others being less so. By owning assets from every major part of the world, it is possible to benefit from the consistent growth of the world economy, rather than placing your bets on a few nations.
Stock-markets in many of the developing, and fast growing, areas of the world can see significant growth, not possible in the larger nations. This means that a smaller allocation of funds can be made in these higher risk/more volatile locations, for the same potential gain of a larger investment in a developed nation.
The concept is to stop trying to time the market, or select the best one, and instead have a well diversified approach, that takes advantage of all global developments. This is clearly a long term plan, and is well suited for pension investments. It is not something that should be considered in retirement, when you are looking to take and income, and vest your capital.
So in summary, look for geographic exposure everywhere. UK, Europe, US, Japan, Asia, BRIC, Emerging markets etc. This includes both large-cap and mid-cap firms.
It is only recently that this type of broad diversification is open to everyone. Online fund platforms are now cheap, easy to use, and easily available for any size of investment. Active and passive funds can be bought relatively cheaply and simply, and can cover almost any sector and location you can imagine. Just take a look at these fund research websites, and see what is available :
In order to further reduce risk, especially from factors that cross borders, diversification of assets is required. It does require much looking back to find major stock market crises which affected many countries. The sub prime mortgage crisis from 2007 to 2010, ed to the tightening of credit across the world, and hit the US and Europe particularity hard.
In these circumstances, whilst stocks and shares were hit hard, other assets classes prospered. Bonds, gold, silver, and commercial property (not residential), had a more positive outcome, after the financial crisis.
By diversifying across many different assets it is possible to reduce sector risk.
One of the key reasons for long term investment, is to avoid the reduction in ‘real value’ of assets. The inflation rate tracks the rise in prices of goods and services. If your savings are not at least staying in line with inflation, they are losing ‘real value’.
Inflation can also be used to your advantage. By diversifying part of your portfolio, and investing in the natural price rises of ‘real’ commodities, you can avoid some exposure to the constant devaluing of money through the printing of currency by central banks. Monetary metals such as Gold and Silver are often a safe haven in times of low interest rates, and quantitative easing.
It’s true to say that if interest rates rise significantly, then cash savings become more attractive. However, over the long term, and as part of a well diversified portfolio, monetary metals and are an important part of owning global growth and inflation. they are also a good hedge against a financial crisis.
An example of the benefit of wide diversification, can be seen in the financial crisis. Yale university, in the United States, have a very large (multi-billion pound) investment fund. They have achieved a steady return for over two decades, taking into account the dot com crash and the financial crisis. During the 2008 crisis a large majority of funds fell by huge percentages. Yale university was able to produce a profitable return in this year due to their commodity holdings, which outweighed their stock investment losses.
The permanent portfolio is a famous investment fund that attempts to benefit from wide diversification, and produce steady returns in all economic conditions.
By taking a look at the portfolio allocation, it can be seen how well it is diversified across geographical locations and asset classes.
As this is such a good investment approach, why doesn’t everybody do it ?
Well there are a number of reasons :
- Most people do not spend enough time researching investment strategies and finance to find the best approach for their circumstances. People are more interested in ‘get-rich-quick’ investments, which the recent crypto-currency boom and bust highlights well.
- Financial advisors are generally not taught to invest globally. They tend to stick to tried and tested fund managers, in low risk established locations. For example Blackrock US stock-market index trackers.
- This is a long term strategy suitable for pensions, or long-term savings. It is not designed to jump in and out of the market, looking for perfect timing.
- It’s important to get tax efficiency right. Taking advantage of wrappers such as Pensions and ISA’s, is very important to maximise growth.
- It is only in the last 10 years this has become feasible for the average investor. Previously it has been almost impossible, and prohibitively expensive to invest globally, and get true international diversification. The advent of cheap and accessible online investment platforms, has made this strategy a real possibility to all investors.
This is the end of part one, which provides an overview, and logic, behind the investment strategy. In part two we will look at the specifics of how to get setup with an investment portfolio that can take advantage of global growth, in a tax efficient way.