LORRAINE GREEN
THE PURPOSE of establishing any investment portfolio is to improve or maximise returns on your money today so that you can meet your future financial needs. Having a well-constructed and actively-managed portfolio, which conforms to these financial objectives, is critical to your success as an investor.
Nevertheless, many investors, whether out of affinity or loyalty to an organisation or an intense aversion to risk, have over 30 per cent of their portfolios in either one asset class, or one stock, or one sector. This financial state of affairs is referred to as overexposure and can, if not monitored carefully, result in your actually 'minimising' your returns and being unable to meet those imminent capital needs.
BEYOND THE STOCK MARKET
Though commonly associated with investing in the stock market, overexposure refers to any significant - generally over 30 per cent - holding in either a single account type - also known as asset class - a particular business, a single sector or an economy.
The overexposed investor will have either only money market accounts, bonds and nothing else or simply stocks, with the businesses owned being domiciled in only one industry, for example, the financial services sector. For other investors, their portfolio is only in investment products denominated in foreign currencies whether U.S. dollars, Canadian or Euros. As such, the investor is exposed to all the vagaries associated with an insularly-constructed portfolio.
NOT ALWAYS A BAD DECISION
It should be stated that overexposure is not always considered a financial faux pas. If the purpose of investing is to maximise returns, then one may have to take a concentrated position in one asset class in order to achieve desired return.
Say, hypothetically, that the U.S. market is not performing as expected and you will not be able to achieve your desired returns, then it may be prudent to overexpose your portfolio to investment products in the Jamaican economy in order to rebalance your portfolio.
Markets are cyclical and at different points in a period of time, the investor will need to reduce his or her risk to a particular product, or a particular business or a single economy through overexposure.
THE DOWNSIDE OF A CONCENTRATED POSITION
The rule of thumb is that diversification allows you to spread your risk so that the value of your investment portfolio can be preserved. Diversification or appropriately allocating your investment portfolio across asset classes, economies, or industries can both reduce risk and foster higher long-term growth.
Adverse economic or natural events can adversely affect particular industries and as such threaten the viability of your portfolio. Again, we will speak hypothetically.
Say that your portfolio is heavily invested in bonds for the oil-producing business - Company X. An earthquake measuring 7.5 on the Richter scale hits. Pipelines, trains and tanks could be destroyed which will impact Company X's ability to distribute its products and its clients' ability to access the product.
Say that your interest payment became due two days after the earthquake. It is not likely that Company X will be able to meet its debt obligation so that you and the other investors can receive that which is due. Your risk then to Company X has negatively impacted your portfolio's performance and is not meeting the target of optimising returns.
DIVERSIFYING
As investment analyst Chris Gallant asserts, "it is not simply enough to own securities from each asset class; you must also diversify within each class."
Investors can use mutual funds to obtain the economies of scale that large volumes of trading enjoy, which the individual investor could not achieve.
BE ACTIVE
Several factors change during your financial life time, including your current financial situation, future requirements and risk tolerance. You will need to adjust your portfolio accordingly, that is, consider your level of exposure.
Lorraine Green is a wealth manager at NCB Capital Markets.
Taken from The Sunday Gleaner, October 9, 2005
