Category Investments

Global volatility highlights need for diversification across asset classes

23 March 2011 Blue Ink Investments

The volatility in local and global equity markets as a result of recent political unrest, soaring food inflation, sovereign debt default risks and environmental factors have once again highlighted the need for proper diversification across asset classes, within investment portfolios.

During the month of 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 devastating Tsunami that hit Japan in March, sending stock markets plummeting by as much as 12% in some cases.

In contrast, the monthly Blue Ink All South African Hedge Fund Composite (BIC), which tracks the performance of hedge funds in South Africa, registered a marginal decrease of 0,03% during the month.

According to Eben Karsten, portfolio manager at Blue Ink Investments, volatile short-term investment returns reinforce the argument for diversification – or the balancing of portfolios across a variety of asset classes.

“There was a major rotation out of emerging markets into developed markets as risk aversion took centre stage through February. 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, “says Karsten.

He says the hedge fund industry offers a number of investment strategies across the risk / return spectrum. ”Fund managers cannot predict when market sentiment will swing from positive to negative; but they can protect investors’ assets from periods of market turbulence by ensuring adequate 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,” says Karsten. Foreign investors were net sellers of local bonds based on their expectation of the SA Reserve Bank hiking interest rates in the next 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,” concludes Karsten.

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