The Value of Diversification

Diversification is all about spreading your investments over a range of assets, managers and markets. It is an excellent and proven way to reduce the risk of financial disasters.

Constructing an investment portfolio is like assembling a winning sports team, where a good team is more than the sum of its parts. Each team needs individuals with different strengths so that they work together and outperform the team with a few star players.

Diversification is not about having ten investments instead of five. The core idea that makes diversification work for you is ‘correlation’. If eight of your ten investments move together – go up and down together – then you have eight strongly correlated investments. However, if each of your five investments moves at different times and rates, then your portfolio is diversified in an efficient manner. Making diversification work for you is not about winning the premiership every year but choosing the right mix of investments with low correlations to achieve the returns you need each and every year to meet your clients financial and lifestyle goals.

Should you care about “correlation”? Absolutely! Understanding correlation will help you to know if your portfolios are properly diversified.

One key way to achieve diversification of an investment portfolio is via diversification of asset manager styles. At RE:CM we believe that It is very hard to generate exceptional returns when you are doing exactly what everyone else is doing, this is why we have built a mechanism into our investment process to force us to do what does not come naturally – buy what is out of favour and avoid the flavours of the day. Our investment process thus requires us to act in a contrarian fashion. It is exactly when everyone agrees on the investment merits of a specific asset that they are most likely to be wrong – and the investment risk of the asset is at its highest. If you do exactly the same thing as everyone else the outcome will at best, be average. We believe we are paid to deliver superior real returns over the long term.

A well-constructed diversification strategy benefits from solid research and sound advice. Selecting the correct “blend” of asset managers is of vital importance, ensuring that they have low correlations. Relying on one fund manager for all your investments may be placing too big a bet on that manager’s success.

Diversification is a key element of sound financial planning. A portfolio that is well diversified will sustain its value during market declines much better than one that is not. The result is a portfolio that is rarely the top performer of the year. But it is rarely the biggest loser, either.

How is RE:CM different?

Our focus is on investing in securities that are cheap in absolute terms. Typically this often means our portfolios have less volatility than the market and peers who are more benchmark-oriented. Having the ability to stick with our conviction and deviate from the crowd allows us to take advantage of market inefficiency and gives us the potential to generate superior returns over time. Below is a performance versus volatility scatter chart that confirms exactly this: That the RE:CM Global Fund has generated higher than average returns with significantly less volatility than the peers below in the SA offshore universe.

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The Allan Gray-Orbis Global Equity Feeder Fund remains fully invested in global equities. The objective of the Fund is to outperform the FTSE World Index at no greater-than average risk of loss in its sector.