Make sure you diversify when you diversify…

The merits of “not putting all one’s eggs in one basket” have long been highlighted in the investment arena, but can investors who embrace the concept of prudent diversification be sure they are as diversified as they think?

The question is raised by Miranda van Rensburg, head of Manager Research at Absa Multi Management, following an investigation of the level of commonality across many local unit trusts.

The study reveals that less diversification might be present than one thinks, giving investors the delusion of prudent risk-spreading across the equity asset class when the same old favourites might feature right across the mix.

Van Rensburg cautions: “Care should be taken when choosing where to invest as it seems there is a high level of consensus among some South African fund managers’ top holdings as to where investment opportunity currently exists.

“Our analysis of the top 10 holdings as at 31 December 2011 across some very popular equity unit trust funds provides food for thought for investors who might be diversifying without achieving anything like the intended degree of diversification.”

The table below shows the percentages held in some stocks by these unit trusts:

The “usual suspects” (Anglos, MTN, Sasol, Old Mutual and Standard Bank) appear in the top 10 of many of these funds, says Van Rensburg.

The Absa Multi Management study indicates that on average these five stocks make up around 26% of any of these unit trusts.

Van Rensburg notes: “Granted, many of these funds have a mandate to provide a return relative to a JSE All Share benchmark that is heavily weighted with the above stocks.

“But the end result for the investor is what counts. And for an investor who thinks he is doing the appropriate thing by diversifying his portfolio across a number of these funds a nasty surprise can result should there be a hiccup in the local market and these stocks all start declining simultaneously.

“What’s more, the investor typically pays separate fees for each of the funds he invests in.”

However, multi-management specialists are able to identify funds that take a unique approach and invest in very different shares or allocate very different weights to the shares in their portfolio.

“One of our points of focus is portfolio construction that is specifically designed to secure effective diversification,” says Van Rensburg. “Portfolio diversification indices are constructed to ensure that funds within Absa Multi Management portfolios contribute positively to diversification when blended together, resulting in enhanced risk-adjusted returns for investors.”