In previous installments I have talked about the importance of diversification. Diversification must be a conscious act whose ultimate goal is to optimize the expected returns with respect to risk.
It is always a good time to delve into the subject after having had the chance to see that many people still do not fully understand the concept.
During the week, a co-worker came to talk about the market and asked me for a bit of guidance regarding her investment portfolio.
Let’s highlight the positives…
For starters, she has an investment portfolio, she is aware of the need to start building up assets from an early age, and most importantly: take matters into her own hands, it is not only the fact that she cares, she looked for guidance.
Diversification by asset classes, types of instruments, regions, and stocks.
Major divisions are usually fixed income, backed by government or corporate debt, and equities, represented by shares of public companies. Historically, returns on equities have been higher than those of fixed income, in the long term. On the other hand, the returns of fixed income have shown less volatility over time.
Types of instruments
There are Mutual Funds, ETFs and stocks. Mutual funds are diversified portfolios, actively managed by experts, whose target is to beat a given benchmark. ETFs passively replicate the composition of international indexes, such as the S&P or corporate debt indexes of some region, etc. As for stocks, investors can decide whether to buy Amazon, Facebook, or GE shares, to name a few.
Several studies have shown that investors often overweight their exposure to securities in their region, in other words, they have more shares of the country where they live. That is, they put into practice the: buy what you know.
Actually, today, there are a large number of companies with global operations, regardless of their country of residence. Furthermore, digital platforms facilitate investors around the world to buy shares from foreign companies, even from their smartphones.
It should be noted that there is no universal recipe that suits any situation. Today, experts have a theoretical framework, based on evidence and experience, which supports the creation of portfolios adapting to the profile of the investor, and the investment itself (objective, amount, and time horizon).
Returning to the Alejandra’s case, when talking about the diversification of her portfolio, she told me that half was dollarized and the other half in Mexican Pesos. Approximately half in diversified funds and the other half in shares in Pesos. Without issuing a judgment on the weights, it would seem to be covered, but delving into a bit, this is what I discovered.
The half that was invested in funds was predominantly in US equity indices, and the half that was in “pesos” was invested in US technology stocks through the Mexican Bolsa.
Hence, there was no real diversification in asset classes. In different presentations (types of instruments), the behavior of her investment would depend entirely on the path followed by the Us equities. Meaning greater volatility.
In terms of regions, most of the companies were domiciled in the US, geographic diversification depended on the operations of each of these enterprises at a global level, and the values of the shares had a direct reliance on dollars. There was an implicit diversification, however, there was an area of opportunity.
Finally, in terms of diversification in stocks, although the stock picking was focused on technology companies, her participation in ETFs that follow global indexes achieved the desired diversification effectively.
Although a first diagnosis points to areas of opportunity, all is not lost. We will be talking to find out her objectives in depth, and design a more balanced strategy that can be executed in a conscious and consistent manner.
Sometimes, trends or market movements can incline us to make visceral decisions, which may even grant us favorable results. However, it is very important to be aware of, and to measure, the risks associated with deciding to maintain or change our strategies.