January 2013
Diversification –
A tested investment principle
Learn About
Investing
Market volatility is not a new phenomenon. 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
Crisis situations are not new ideas to the markets. While
market volatility often burns confidence levels among
investors, “stay invested” and “be long- term focused” are
likely the key lessons to be learned.
g
With uncertainty over US fiscal cliff, sovereign and economic
crisis in Europe and geopolitical situation in the Middle East,
2013 is expected to be another year of Risk On/Risk Off.
g
While Risk On/Risk Off makes investment challenging, there
is a silver lining for multi asset investors as investments are
benefit by diversification.
g
Historically, stock markets often resumed their
upward trend within a short space of time
post major events
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.
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.
Major crisis in global stock market over the past 30 years
6,000
Aug 98:
Bailout of LTCM
5,000
Aug 90:
Gulf War
4,000
Oct 87:
Black Monday
3,000
2,000
May 10: European
sovereign debt crisis
00 - 03:
Dot com crash
03: SARS
outbreak in Asia
97-99: Asian
financial crisis
94: Mexican
currency crisis
Aug 82: Mexican
sovereign debt crisis
07-09: Global
financial crisis
Aug 98: Russian
Debt Default
1,000
Q3 11: S&P
downgrades US
Credit Rating;
Concern on
global recession
Sep 01: Terrorist
attacks in US
0
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
Source: Morningstar, MSCI, Fidelity. Performance of the global stock market based on the MSCI World Gross Index (USD) from 1 January 1980 to 31 December 2012.
2012
January 2013
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
80%
Global Equities
Global Property
60%
Global High
Yield Bond
40%
Global
Government
Bond
20%
0%
-20%
-40%
-60%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: Morningstar, MSCI, data as of 31 December 2012. Performance of asset classes as measured by the MSCI World Gross (USD), S&P Global Property ($US) indices, BofAML
Global High Yield TR (USD), and Citigroup World Government Bond (USD) respectively.
Diversification is also important at the company level. 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. Stock prices of growth companies
tend to outperform as economic conditions improve as their earnings are more sensitive to economic conditions.
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
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
49%
29%
29%
37%
34%
-21%
62%
25%
10%
30%
Info Tech
Utilities
Energy
Utilities
Materials
Health Care
Materials
Cons Disc. Health Care Financials
46%
29%
20%
33%
30%
-23%
53%
24%
9%
25%
Materials
Energy
Materials Telecom Svc.
Energy
Cons Staples
Info Tech
Industrials Cons Staples Cons Disc.
40%
20%
14%
29%
22%
-29%
40%
22%
2%
18%
Financials
Industrials
Utilities
Materials
Utilities
Utilities
Cons Disc.
Materials Telecom Svc. Health Care
39%
18%
12%
24%
22%
-32%
32%
13%
1%
17%
Industrials
Materials
Industrials
Financials Telecom Svc. Telecom Svc. Financials Cons Staples
Energy
Industrials
38%
18%
12%
21%
19%
-38%
28%
13%
-2%
14%
Cons Disc.
Financials
Financials
Cons Disc. Cons Staples
Energy
Industrials
Energy
Info Tech
Cons Staples
29%
18%
9%
21%
16%
-41%
27%
11%
-2%
14%
Utilities
Telecom Svc. Health Care Cons Staples Industrials
Cons Disc.
Energy
Telecom Svc.
Utilities
Info Tech
27%
15%
6%
19%
15%
-43%
23%
11%
-4%
12%
Energy
Cons Disc. Cons Staples Industrials
Info Tech
Industrials Cons Staples
Info Tech
Cons Disc.
Materials
26%
12%
5%
18%
4%
-44%
20%
5%
-8%
8%
Telecom Svc. Cons Staples
Info Tech
Energy
Health Care
Info Tech
Health Care Financials
Industrials Telecom Svc.
20%
6%
2%
11%
-3%
-50%
15%
3%
-18%
3%
Worst
Materials Telecom Svc. Health Care Financials
Utilities
performing Health Care Health Care Cons Disc. Health Care Cons Disc.
17%
3%
-9%
10%
-8%
-54%
7%
0%
-20%
3%
sector
Cons Staples
Info Tech
Telecom Svc.
Info Tech
Financials
Financials
Utilities
Utilities
Materials
Energy
Best
performing
sector
Source: Morningstar, MSCI. Performance as of 31 December 2012. Sector: Cons Disc.: MSCI World Consumer Discretionary Index GR USD. Cons Staples: MSCI World Consumer Staples
Index GR USD. Energy: MSCI World Energy Index GR USD. Financials: MSCI World Financials Index GR USD. Health Care: MSCI World Health Care Index GR USD. Industrials: MSCI
World Industrials Index GR USD. Info Tech: MSCI World Information Technology Index GR USD. Materials: MSCI World Materials Index GR USD. Telecom Svc.: MSCI World Telecom
Services Index GR USD. Utilities: MSCI World Utilities Index GR USD
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