Portfolio Diversification versus Portfolio Insurance

Portfolio Diversification versus Portfolio InsuranceHow can I protect against a loss of investment capital?

Since the GFC there’s been a lot of talk about ways to protect investment portfolios from the types of falls experienced in late 2008. There are two ways to overcome this risk: portfolio diversification or portfolio insurance (or hedging). We’ve compared the two in this article.

Portfolio diversification involves the practice of combining investments with low correlation to reduce the overall volatility of the portfolio. This invariably means holding some “losers” amongst your “winners”; a practice that often doesn’t sit well with a “winner’s” mindset.

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Index Investing: Naïve or Smart?

Index Investing: Naïve or Smart?

What is index investing?

Many investors shy away from index investing because they deem it to be too naïve for their investment purposes. There’s definitely a higher seduction factor associated with a bottom up, active investment approach. Yet the recent trend has clearly been towards index style investing (due largely to the dissatisfaction with actively managed investment alternatives).

An index is a statistical measure for determining the performance of a portfolio of constituent investments. Charles Dow created the first (“Dow Jones”) index back in 1896 to act as a proxy for the performance of the US stock market as a whole.

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Active versus Passive Investing: The “Alpha” Bet

What is “Alpha”?Active versus Passive Investing: The “Alpha” Bet

In investment terminology, “alpha” refers to the level of outperformance of a portfolio relative to an appropriate benchmark. Of course, everyone would like to achieve returns in excess of their benchmark. But you’re advised to have a good grasp of the cost and chance of achieving alpha before you decide to chase it.

There are two broad approaches to investment management: active and passive. An active approach seeks to add value, or alpha, by over weighting exposure to securities that are believed to be undervalued and under weighting those believed to be overvalued. The obvious aim is to perform better than a strategy that simply holds all securities according to their market weight (i.e. benchmark portfolio).

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International shares: To hedge or not to hedge?

Strong Aussie dollar wipes out international share gains …
international shares
In our recent article, “Should you hold international shares in your investment portfolio?”, we argued that there are diversification or risk reduction benefits from holding international shares as part of a share portfolio. To keep it manageable, we did not directly address the exchange rate risk that comes with owning shares denominated in another currency.

However, with the Australian dollar (AUD) appreciating 36% against the US dollar (USD) and 25% against the Reserve Bank’s trade weighted basket of currencies over the six months to September 2009, we are concerned that some poor decisions are being made in response.

The past six months has seen strong local currency gains in international shares almost completely offset by exchange rate losses when converted to AUD. This has resulted in some investor disenchantment with international shares. The knee jerk reaction has been to either reduce the international share allocation and/or to choose share funds that are protected against exchange rate movements i.e. hedged.
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Franked dividends and your investment strategy

Is franking a free lunch …Franked Dividends - Free lunch?

Many D-I-Y investors skew their investment portfolios towards shares that pay franked dividends. This is particularly prevalent amongst trustees of self managed superannuation funds who appear to over value the benefit of franking credits.

There appears to be a view that franking offers “a free lunch”, resulting in its overemphasis as a driver of investment strategy.

We believe investors should not favour particular shares simply because they pay franked dividends. The usual thinking behind such behaviour is, in our view, flawed.
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Five Things To Remember In Difficult Times

“I have not looked at any of my holdings and don’t intend to. I don’t want to be tempted to jump because I think I’d be more likely to jump in the wrong direction than the right one. My advice has always been to choose a sensible diversified portfolio and stop reading the financial pages. I recommend the sports section.”

Quotation attributed to Richard Thaler, professor of behavioral science and economics, University of Chicago Graduate School of Business.[1]

These are difficult times – nobody knows how and when markets will stabilise. We appreciate the emotions they arouse. But you should take some comfort  that our planning process is not driven by what is happening in the market at any point in time. It focuses on achieving your long term financial objectives, based on reasonable projections of long term investment returns.
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