Junk status: Diversification is key to protect against market shocks

Jeanette Marais, director of client services and distribution at Allan Gray.

The recent downgrade of South Africa’s investment grade status to junk by more than one international ratings agency has highlighted the importance of having a diversified investment portfolio.

This is the view of Jeanette Marais, director of client services and distribution at Allan Gray, who says that the best thing South African investors can do during periods of heightened uncertainty is to stick to their investment plan.

“If you have chosen the right fund with a long-term track record of performing through the cycles, or created a portfolio that is well-diversified across currencies and asset classes, do not panic. A diversified portfolio limits the risk of permanent capital loss, but still maximises the probability of real returns,” says Marais.

She says that investors should regularly review their portfolios, but take caution against making investment decisions that are in reaction to market news and movements.

“While it is clear that we are currently in a period of uncertainty, investors must try to remain calm, tune out the market noise, and continue investing in line with their objectives and risk tolerance. If you second guess your investment strategy based on short-term news, you can end up destroying a lot of value.”

She adds that in many cases experienced investment managers would have already geared for potential market shocks in their funds.

“If your portfolio includes holdings in well-diversified businesses whose earnings are generated offshore and not in South Africa, there is a good chance that the fund you are invested in is well-positioned to withstand negative market sentiment, such as with a downgrade,” says Marais, adding that a well-diversified portfolio should include offshore investment.

She says that in the past South African investors have flocked offshore in response to rand weakness. This is counterintuitive and expensive.

“A better solution is to appreciate ongoing diversification and not try to time currency movements.”
Marais adds that opportunities at home should not be discounted.

“Many solid local businesses have proven that they can withstand market shocks. If their share prices are impacted by a widespread sell-off of domestic assets, this could present a good investment opportunity.”

Marais says that it is critical for investors to ensure that their investment managers continually reassess risks and potential returns as circumstances change; making appropriate portfolio changes over time.

“This is the key to ensuring that your capital is protected against permanent loss during periods of underperformance and market uncertainty, both of which are inevitable,” she concludes.