The right approach to diversification can safeguard wealth, and maximise investment growth
NEDBANK PRIVATE WEALTH
EVERY INVESTOR is familiar with the concept of diversification, but not everyone fully grasps its significance and the profound impact it can have on their investment journey.
Diversification is not just a vague principle—it’s a deliberate strategy that requires careful consideration, and an open mind.
A recent webinar hosted by Nedbank Private Wealth brought together a panel of international investment experts, who shared key insights into why diversification is so crucial, what makes for effective diversification, and how to effectively implement it to safeguard your wealth and seize opportunities for growth.
The importance of avoiding home bias
Most investors have a tendency to favour assets from their home country. This ‘home bias’ stems from a perception of greater control and familiarity with local investments. However, the panellists agreed that limiting yourself to domestic investments can hinder portfolio growth, and expose you to higher risks.
To illustrate this point, Adrian Saville suggested an exercise in which a South African investor imagines a view of the global economy and its full investment opportunities from outer space.
Based on such a full view of the global investment universe, he argued that the logical allocation to South African-based investments would be minuscule, probably around 0.5% of one’s total port-folio—illustrating the importance of looking beyond home-based investment options.
Hein Klee concurred, and also pointed to the importance of understanding that the world economy is vast and diverse, and that it extends far beyond the United States and the US dollar.
While US assets may have performed well historically, it’s vital to resist the allure of focusing solely on familiar giants like Microsoft, Nvidia, or Google. Broadening your view allows you to tap into investment opportunities worldwide, reducing dependence on a single currency—especially in an unpredictable interest rate environment.
Understand the essence of true diversification
The panellists agreed that for diversification to work, you need to ensure that it’s not just a geographic consideration.
What you invest in as part of your di-versification strategy needs to behave differently from what you already own, or what is available in your home country.
For example, if you recognise a need to diversify away from South African equities, you are not going to achieve the required portfolio diversity by investing in equities within BRICS countries. That’s because equities in these regions behave very similarly to South African equities.
Therefore, just because a share has a different name, or it’s in a different place, that doesn’t mean it is an effective diversifier of your portfolio.
Don’t overlook other emerging markets
While the tendency amongst many investors is to think of diversification mainly as gaining exposure to mature or advanced markets, Nicky Weimar pointed out that many emerging markets have performed remarkably well, and have shown good resilience in recent years.
Hein Klee reminded webinar viewers that emerging market diversification doesn’t necessarily require investing directly into international stocks domiciled in those markets. Investing in global brands can provide indirect exposure to emerging markets, allowing investors to tap into the growth potential of emerging markets and mitigate the risks as-sociated with a concentrated domestic market.
Avoid the temptation of cash
Hein Klee also urged investors to not be tempted by the apparent appeal of the interest-earning potential of cash, even if it is earned in dollars. This is particularly a symptom of the current higher interest rates in the US and Europe.
However, despite this, it’s important to remember that historically, cash has not outperformed inflation in the long run—and it is unlikely to do so in the future.
While you may feel safe putting all your eggs into the cash basket, the truth is that you are exposing yourself to a significant risk, arguably a certainty, that the performance of your assets will underperform most other asset classes over time.
Components of an effective diversification strategy
Simon Watts offered useful practical suggestions on structuring a robust and effective diversification strategy, which he suggested should be built on the following core principles:
- Have a clear and repeatable process: Establish a disciplined investment process that helps filter out market noise, and keeps you focused on your long-term goals.
- Diversify across assets: Allocate investments across various asset types, regions, strategies, and styles. Be mindful of any built-in biases when investing in funds, ETFs, ETNs, or similar instruments.
- Consider different outcomes: Understand the potential outcomes of different assets, and how they interact with each other, to build a resilient portfolio.
- Align risk and timeframes: Match your risk tolerance with the timeframes of your investments, ensuring that your portfolio is suitable for your financial goals.
- Have a bias toward quality: Favour quality stocks that have a proven track record of protecting margins and delivering consistent performance.
- Price matters: Paying the right price for assets is essential. Avoid speculation, and prioritise quality stocks with low leverage and sustainable margins.
- Seek professional advice: Consult financial experts to make informed decisions and avoid costly mistakes.
Key insights
The key insight to emerge from the webinar is that diversification is not merely an investment catchphrase; it is a strategic imperative for any prudent investor.
This imperative is one that—if approached correctly—will not only shield your portfolio from wealth-eating forces like taxes, inflation, and market volatility, but also unlock the potential for remarkable growth over time.
The webinar panellists were:
- Simon Watts, senior portfolio manager at Nedgroup Investments in London.
- Hein Klee, head of international at Nedbank Private Wealth.
- Adrian Saville, professor of economics at the Gordon Institute of Business Science, University of Pretoria.
- Nicky Weimar, Nedbank group economist.
