"The collapse of Steinhoff left very few funds unscathed, but it reminded us of the benefits of diversification," writes Vimal Chagan, Divisional Director of Investment Propositions at Liberty.
Diversification is what we in the asset management industry call “a free lunch” as it reduces the overall risk of the portfolio with a limited drop in return over the long-term. In the short-term, diversification across companies and asset classes means that a single event – positive or negative – has less impact.
While the Steinhoff example shows how limiting your exposure to a single share would have protected your overall portfolio, limiting exposure to a single share that has risen significantly means your returns would be more muted. (Reducing exposure to a share that performs badly will limit your losses, but by the same token, if the share prices rise substantially, your gains are also limited as it makes up a smaller percentage of your portfolio.)
Yet in the long-term, as different asset classes perform well or poorly at different times, a diversified portfolio provides a reasonable return without the roller-coaster ride of being invested in a single asset class portfolio.
Understand your real risk and diversify
When looking at risk, we need to understand what it really means. When we talk about Steinhoff, we think of market risk and the chance that the value of your investment will fall in the short-term.
Diversification can help lessen that risk, as can investment products that offer capital protection, such as the High-Water Mark Guarantee in Liberty’s Bold and Agile products (read our article on the High-Water Mark Guarantee in this newsletter for more details).
The other risk is that you don’t meet your investment goal(s) because you have been too conservative. If the fear of exposing even a small percentage of your portfolio to a corporate meltdown makes you switch all your money into a low-growth, conservative fund, you may sleep better at night in the short-term. However, unless you increase the amount you invest each month to make up for the lower growth, you will definitely not be sleeping well in the future.
Understand probabilities to make sensible investment decisions
Another way to look at risk is to consider probabilities. There is always the probability that the stock market will go down in the short-term. However, the probability of a well-diversified growth portfolio delivering negative returns reduces with time. In comparison, the probability of a conservative portfolio delivering negative returns in the short-term is low, but the probability of you not reaching your investment goals increases over time. You have to look at your risk and the probabilities associated with that risk and make sensible investment decisions that mitigate those risks.
And on the topic of probabilities, the likelihood of another Steinhoff debacle is lessened as a result of the scandal being uncovered. More rigorous questions will be asked both by auditors and investors. Loopholes will be found and closed, and reporting standards will be raised. Non-executive directors and auditors don’t want to see their names in the newspapers and you can be sure that a lot of questions are being asked at board meetings across the country.
Steinhoff was a shock, but it was an isolated incident. It would be dangerous to throw the baby out with the bathwater and give up on the whole system. Understand your risks and mitigate them where you can, but don’t react in or to fear.
Share this article:
Linked In | Facebook | Twitter | Email |
