Diversification - A tested investment principle Learn About Investing

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December 2011
Learn About
Investing
Diversification - A tested
investment principle
The scale of the recent stock market turmoil has certainly taken its toll on investor confidence, leaving many to become
extremely hesitant about investing in stock markets. But market volatility is not a new phenomenon and while many
crisis events are etched in the minds of the investing public, few will recall that after each crisis markets tend to return
to their previous levels within a relatively short period of time. This Learn About Investing provides a timely reminder
of the stock market’s return profile over the long term and the importance of adhering to tested principles of successful
investment.
At a glance
caused by terrorist attacks in 2001. Numerous investors are still
experiencing the impact of the 2008 credit crunch and global
recession.
n Market volatility is once again, burning confidence levels
among investors, with growing uncertainty over the future
of the euro, America’s ability to halt its deficit escalation
and China’s ability to withstand these offshore headwinds.
Markets do not like uncertainty and often overreact to new
developments. The short term-ism that characterises market
psychology often means investors react to new developments
with a worst-case scenario mindset. Add the herd mentality
that also characterises investor behaviour and the result can
be a huge disparity between stock market valuations and the
net worth of companies they represent.
n Crisis situations are not new ideas to the markets. Many
have been and gone before and each offered a set of
lessons to be learned.
Time and time again, investors fail to keep crisis events in
perspective. Actually casting the mind a little further beyond
the recent history is where many lessons may be learned. As
unsettling as dips can be, long-term history has shown that
while stock markets have reacted strongly to major events,
they have often resumed their upward trend within a very short
space of time.
Just another market crisis
Currency collapses, terrorist attacks, hedge fund failures…there
have been numerous crisis events that have affected stock
markets over the past century. Many will vividly recall the 1997
Asian Financial Crisis, the 1999 internet bubble and the turmoil
Major crisis in global stock market over the past 30 years
00 - 03: Dot
com crash
6,000
Aug 98: Bailout
of LTCM
5,000
Index
4,000
Aug 82: Mexican
sovereign debt crisis
3,000
Aug 90:
Gulf War
Oct 87: Black
Monday
03: SARS
outbreak in Asia
97 - 99: Asian
financial crisis
94: Mexican
currency crisis
2,000
1,000
Aug 98: Russian
Debt default
Sep 01: Terrorist
attacks in US
07 - 09: Global
financial crisis
0
1980
1985
1990
1995
2000
Source: MSCI, Fidelity. Performance of the global stock market based on the MSCI World Gross Index (USD) from 1 Jan 80 – 31 Aug 11
2005
2010
December 2011
Diversification - A tested
investment principle
A portfolio should be diversified across asset classes to
reduce risks and smooth returns. Defensive assets such as
bonds and cash tend to fare better during periods of high
market volatility, while growth investments like property and
stocks provide attractive returns when economic conditions
are expected to be more favourable. The value of bonds
and stocks can often move in opposite directions, but taken
together, a portfolio that invests in a range of quality assets
should deliver attractive returns with lower risk.
Asset class performance
50%
Global
Equities
40%
Global
Bonds
30%
20%
Global
Property
10%
0%
-10%
-20%
Diversification is also important at the company level. During a
market crisis, dramatic falls on global stock markets dominate
the news headlines and lead readers to assume that every
stock has collapsed in value. However, this may not be the
case. Certain sectors of the market often perform better than
others at different points in the economic cycle.
During a downturn, market conditions tend to favour so-called
defensive stocks, as these companies are less affected by
economic cycles, can maintain earnings and continue paying
dividends. Companies like electricity and gas distributors are
classic examples. They generally operate under fixed, long
term supply contracts and can pass on rising costs directly to
the consumers who require energy to power their homes.
Stock prices of growth companies tend to outperform as
economic conditions improve as their earnings are more
sensitive to economic conditions. The tourism industry is often
one of the first to benefit from growing incomes and personal
wealth as people tend to spend more on leisure travel.
-30%
-40%
-50%
-60%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
YTD
Source:Bloomberg, MSCI. Performance of asset classes as measured by the Citigroup
World Government Bond (USD), MSCI World Gross (USD) and S&P Global
Property ($US) indices, respectively.
This is not to say that all defensive stocks will outperform
during downturns; sometimes a traditionally defensive sector
may not be favoured due to a range of other factors such as
changing industry trends, government policies and competition
from other companies. Given that sector return profiles vary
according to a broad range of factors, a well-diversified stock
portfolio that invests in a range of industries will generally
smooth out the impact of the market’s highs and lows.
Annual sector returns - market leadership varies from year to year
Sector Returns
-10% Consumer -11% Consumer
Staples
Disc.
-14%
Health Care
2001
-7% Materials
-9% Energy
2002
-5% Consumer
Staples
-6%
Materials
-8% Energy
-18%
Financials
-19% Utilities
2003
48%
Info Tech
42%
Materials
36%
Industrials
36% Consumer
Disc.
36%
Financials
2004
25% Energy
24% Utilities
18%
Industrials
16%
Materials
15%
Financials
2005
26% Energy
17%
Materials
10%
Industrials
10%
Utilities
9%
Financials
2006
32% Utilities 28% Telecomm
Serv.
26%
Materials
21%
Financials
2007
2008
31%
Materials
27% Energy
-17%
Industrials
-19%
-23% Consumer
Health Care
Disc.
24% Utilities
23% Energy
-24%
Utilities
-26% Telecomm
Serv.
-30%
Info Tech
-24%
Industrials
-30% Telecomm
Serv.
-39%
Info Tech
23% Telecomm
Serv.
18%
15% Consumer
Health Care
Staples
15% Telecomm 14% Consumer 10% Consumer
5%
Serv.
Disc.
Staples
Health Care
8%
Health Care
19% Consumer 18% Consumer
Disc.
Staples
16% Consumer
18% Utilities 18% Telecomm
Serv.
Staples
-18%
Financials
14%
Info Tech
-23%
-25% Consumer -31% Utilities -36% Telecomm -39% Energy -43% Consumer
Health Care
Staples
Serv.
Disc.
4%
Info Tech
2%
Info Tech
4% Consumer 0% Consumer -12% Telecomm
Staples
Disc.
Serv.
17%
Industrials
16% Energy
9%
Health Care
9%
Info Tech
14%
Industrials
2%
Health Care
-5% Consumer
Disc.
-11%
Financials
-44%
Industrials
-44%
Info Tech
-51%
Materials
-56%
Financials
19% Consumer
16%
Staples
Health Care
9% Telecomm
Serv.
2% Utilities
2009
58%
Materials
51%
Info Tech
37% Consumer
Disc.
28%
Financials
24%
Industrials
23% Energy
2010
23% Consumer
Disc.
21%
Industrials
19%
Materials
10% Consumer
Staples
10% Energy
10%
Info Tech
5% Telecomm
Serv.
2%
Financials
0%
Health Care
-5% Utilities
YTD
30/9/11
0%
Health Care
-7% Utilities
-9%
Info Tech
-12% Consumer
Disc.
-15% Energy
-18%
Industrials
-23%
Financials
-25%
Materials
-1% Consumer -7% Telecomm
Staples
Serv.
Source: Bloomberg, MSCI. Performance of sectors in the MSCI World Index (local currency)
To know more, visit www.fidelity.com.hk
FIL Limited and its subsidiaries are commonly referred to as Fidelity or Fidelity Worldwide Investment. Fidelity only gives information about its
products and services. Any person considering an investment should seek independent advice on the suitability or otherwise of the particular
investment. Investment involves risks. Past performance is not indicative of future performance. Please refer to the Fidelity Prospectus for Hong
Kong Investors for further information including the risk factors. Fidelity, Fidelity Worldwide Investment, the Fidelity Worldwide Investment logo and
F symbol are trademarks of FIL Limited. The material is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed
by the Securities and Futures Commission (“SFC”).
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