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When Investing, Patience is Essential

Rather than trying to divine the future in the search for the next hot stocks or markets, a process that often leads to disastrous consequences, individual investors, who have limited time, resources and expertise to delve into the intricacy of investment research, should seriously consider the merits of investing across different asset classes over the long-term, in accordance to their risk profiles.

While such a diversified investment approach may not bring about spectacular returns over the short-term, the concept of investing in multiple asset classes such as equity, property, bond and cash would give investors peace of mind that their portfolios wouldn't be hit with big losses should any single asset class such as equities were to enter into a protracted bearish cycle. Besides reducing portfolio risk, a multiple asset class investment approach could also help investors achieve reasonable and stable returns over time, without the rough rides associated with the traditional equity investment products.

Virtues of diversification
There is a saying that failing to diversify and putting all your eggs in one basket often leads to investment calamities. Without a doubt, the risk of not diversifying enough in your investment portfolio is very real. Putting all your money in one concentrated investment area, for instance in Singapore stocks, can create substantial damage to your investment portfolio if equities were to take a turn for the worst.

Return-hungry fund investors, who have parked too much money in high-risk "red-hot" single country funds in the beginning of this year such as those of China and India (two of the best performing markets of 2007), too would be staring at significant losses of late, given the magnitude of correction these markets have experienced in recent weeks.

To avoid such common investment mis-steps, investors could simply diversify their portfolios by spreading their investments across asset classes and geography. In short, investment diversification simply means holding a portfolio of different assets whose expected returns are not correlated to each other.

The notion that portfolio diversification could reduce investment risk first came about in 1952 when the Nobel-prize winning economist Harry Markowitz made the intuitive and simplistic hypothesis that it is less risky to invest money in a number of securities rather than a single one. What Markowitz discovered was that the unique risk of individual securities can be easily diversified when more securities are added to a portfolio. This is because the net effect of negative and positive forces relating to specific securities would cancel each other out. This simple concept marked the rationale behind portfolio diversification and went on to create a whole host of modern investment theories relating to risks, returns and asset allocation.

Multi-asset class investing
In the years that followed, academics fine-tuned the portfolio diversification theory and further proved that by adding different and uncorrelated asset classes to an investment portfolio, one can produce returns that are both higher and less volatile. The theory gave rise to the concept of multi-asset class investing, which was first embraced by investment professionals managing university endowment funds in the early 1980s.

Since then, the concept has taken off in a big way after gaining popularity with mainstream investors, especially after the protracted global stock market downturn of 2000 - 2002. During that 3-year bear period, several US university endowment funds that had been investing in an array of asset classes surprised many investors by turning in positive returns. Having witnessed the merits of multi-asset class diversification, many institutional investors started adding to their managed funds newer non-correlated asset classes that do not move in lockstep with equities such as real estate, commodity, and even hedge funds.

In addition, the risk reduction element of such products is further boosted with the concept of long-term investing. By taking a longer investment horizon, the concept of time diversification would ensure that even the returns of riskier asset classes such as equities and real estate would be smoothed out as good and bad returns cancel each other out over long periods of time. And the patient investor with a long investment horizon will be duly rewarded with the above average long-term rate of returns in between those of equities and bonds.

Despite merits of multi-asset class investing, many investment products that adopt such a diversification approach do have some shortcomings. The most commonly cited complaint about these products is their "one-size-fits-all" approach, which effectively lumps the risk profiles and inevstment goals of investors together. Investors naturally have a wide range of risk profiles, and many multi-asset class products in the market at the moment, do not take into consideration the risk preference of conservative or aggressive investors. The othe rproblem with such products is their "jack of all trade" feature. It is uncertain whether the fund managers of multi-asset class products have good investment expertise in all the asset classes that they have investment exposure in. Indeed a good equity fund manager may not be a good bond manager.

By HSBC Insurance, The Sunday Times, 4th May 2008