/ 30 March 2011

When global volatility persists, diversify

Global equity markets remain volatile — blame political unrest, food inflation, sovereign debt default risks and environmental catastrophes. What this means for the investor is unclear, but you could do worse than to introduce more diversification across asset classes into your portfolio.

In February, the ALSI rallied almost 2% early in the month before plummeting 5% towards month-end, on the back of concerns over the unrest in North Africa and the Middle East. This volatility continued on the back of the Japan’s devastating earthquake and tsunami. In some cases, stock markets fell by as much as 12%.

Volatile short-term investment returns have now reinforced the argument for diversification, argues Eben Karsten, portfolio manager at Blue Ink Investments.

“The trouble with the ALSI is the constant volatility and the negative external factors that can influence the markets. The geopolitical turmoil in the Mena [Middle East and North African] countries detracted from what initially looked like a strong month for the local equity market,” Karsten says. He suggests looking to the hedge-fund industry, which can protect investors’ assets from market turbulence by ensuring exposure to hedge funds and other defensive assets.

“The BIC ended marginally lower,” says Karsten. “However, a number of hedge-fund strategies outperformed the index over the month, with Long Short Directional funds [+0,25%], Long Short Non Directional funds [+0,57%] and Market Neutral strategies [+0,5%] leading the way. The rotation out of emerging markets was further evidenced in the bond market as the long bond yield rose by 50 basis points.”

Foreign investors were net sellers of local bonds, based on their expectation that the South African Reserve Bank would hike interest rates within six months. Their fears drove the All Bond index (ALBI) 2,1% lower in January. Fixed-income hedge strategies shed, on average, 1,67%.

The BIC has achieved a total return of 32,90% over three years, compared with 25,10% from the ALSI over the same period. Over the past year, the BIC has returned 9,79% versus 18,98% on the ALSI. The three-year volatility on the BIC is just 3,06% versus 22,05%. This volatility means equity investors who enter and exit the market at the wrong time can suffer extensive capital losses.

“Against the global backdrop of civilian unrest, environmental crises, rising food price inflation and the ongoing risk of European sovereign debt defaults, there is a strong case for persisting with conservative asset classes through the first half of 2011. Conservative investments offer positive real returns with very little risk,” says Karsten.

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