Portfolio construction and diversification

As investors, we all want our investments to grow and deliver higher risk adjusted returns despite the prevailing economic environment brought about by the cyclical nature of investments markets due to varying macroeconomic factors like politics, inflation, country growth and others.

For long-term successful investment, it is important for an investor to have and adhere to an investment plan, and one fundamental pillar of that plan should be an asset allocation that ensures portfolio diversification, and which is aimed at attaining the investors’ objectives.

According to the Cytonn Investments weekly report, diversification was referred to as a management technique that aims to minimize risk in a portfolio by spreading investments across a range of securities and asset classes, with the notion that a single negative event will not adversely affect all securities held in the same way and to the same degree.

Diversification comes from the time-tested analogy – “don’t put all your eggs in one basket”. The rationale behind this contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment within the portfolio. Where an investor has a significant conviction on a certain asset class or security then one can hold a more concentrated portfolio.

The report noted that diversification comes along with many proven benefits, however, it does not guarantee an investor protection against a loss. Furthermore, diversification does not reduce the systematic risk of investing in a particular market.

This systematic risk is what is referred to as non-diversifiable risk or market risk. It is the risk not associated with a particular company or industry. Non- diversifiable risks include inflation rate risk, exchange rate risk, political instability risk, and interest rate risk. They are the risks investors must accept willingly in order to invest.

In order to diversify your portfolio, one can invest in a variety of asset classes, which include: Fixed income, Equities, Real estate and Structured products.