Diversification

[kennynah]

when one's investment is all equities-centric, no amount of diversification within it can totally eradicate risks post by this asset class...perhaps the only way is to get into different categories of equities. by this i mean, different sectors and types; eg stocks of commodities, metals, oil, etc...

but if risks mitigation is the intent, diversification is not always the best choice. employing appropriate hedging is perhaps a better option...

unfortunately, when participating only in stocks, there are fewer hedging techniques. if you are accustomed to Options, you will discover that one can hedge away delta or gamma or theta or vega or a combination of these to achieve the desired effects...

[Musicwhiz]

I would argue that Japan is a pretty unique example of an "outlier", where valuations hit such stratospheric levels in late 80's that it resulted in an entire "lost decade". Also, a friend who went there told me the infrastructure is near flawless, which means there is not much room for building stuff and economic growth; this could be a contributing factor as well.

Remember that NASDAQ also hit an all-time high of 5,000+ in 2000, then collapsed during the dot.com bust. Right now, it has yet to touch 2,500!! And it's been 9 years.....

[kennynah]

hence... no amount of diversification within 1 asset class is proper risks management...

[winston]

...perhaps the only way is to get into different categories of equities. by this i mean, different sectors and types; eg stocks of commodities, metals, oil, etc.....

Not possible. last year, Properties, Equities and Commodities all dropped at the same time..

So the Equities in your portfolio, across various Industries, across different Countries would still crash.

We can say that last year was also an outlier, a Black Swan but those are times that you get hit badly. Having a diversified portfolio will not protect me from being hit ..

[iam802]

On Japan. My Jap friend says they don't touch the stock market since the AFC.

I think an entire generaton stays far far away from it.........

[kennynah]

...perhaps the only way is to get into different categories of equities. by this i mean, different sectors and types; eg stocks of commodities, metals, oil, etc.....

Not possible. last year, Properties, Equities and Commodities all dropped at the same time..

So the Equities in your portfolio, across various Industries, across different Countries would still crash.

We can say that last year was also an outlier, a Black Swan but those are times that you get hit badly. Having a diversified portfolio will not protect me from being hit ..

u are right.... let's face it...there's no such thing as totally no risks...then there'd be no reward... asset allocation is still among the better choices to reduce total collapse of all assets...but hedging is better option...

[cif5000]

Thank you guys for the wonderful contribution. I have found my answer.
To sum up my thoughts very quickly.
1. Diversification does not improve returns.
2. There are no fixed rules on diversification. You make your own rules.
3. Diversification is a (strong) form of insurance, against the unknown unknown.
4. Diversification is a (weak) form of risk management. It should be coupled with a thorough understanding of the company.
5. Portfolio size matters, but the principle of diversification remains the same.

For the rest of the Asset Allocation discussion, perhaps Winston can put that in the right Thread. (Shoot some arrows here)

[ghchua]

Dear all,

Japan always came out as an example when some doubters are against diversification and buy/hold investment. But frankly speaking, having a diversified portfolio meant that one have to diversify across countries, sectors etc.

Hedging introduces costs and unless one is confident enough to hedge at the right time, costs will eat away returns from the portfolio if one hedges all the time. Using options might be able to hedge away the greeks, but S'pore market is not really developed for options. Anyway, using options to manage risk will present another set of problems - like managing all those option strategies etc.

To make it simple, if one is confident that the world will be better in the future than now, then buy and holding a basket of diversified assets in the portfolio (be it stocks, bonds etc) will suffice. Be disciplined enough to add onto your portfolio every month. Ignore market cycles and noises. Re-invest your dividends/coupons back into the portfolio. Have an investment plan and plan your asset allocation according to your investment plan.

I can't explain my investment strategy more simple as the above. It had been my strategy since I started investing.

[kennynah]

sounds like a plan....good luck !!

[cif5000]

I note that your portfolio consists of >30 companies? Just curious as to how much attention do you devote to each, and is it based on the complexity of the business or the weightage of that company relative to your portfolio size (e.g. 10% of your money is in Company A so you spent more time on Company A than other companies within your portfolio?).

I have more than 40 now. All things being equal, the more time I spent understanding the company, the more money I dare to put in (provided there are merits). Not the other way around (i.e. more money put in therefore I need to spend more time watching). In fact, the job of investing is mostly done when the stock is bought. The rest of the time is to identify new risks and see if the original reason is still valid, and also watch over the assumptions. Check the dividend, and also the share price to see if more can be added or sold. This is for the Good Business category (I hope to have more of these). This is not difficult.

For Asset Play, watch the underlying asset value and management action. It's not difficult.

For Insight Play, e.g. if the company is going to announce a result that will cause the current share price to be only PE 3.5 for example, then after the announcement, the share price will have to go up. The job is to watch the share price after buying and sell with some money left on the table. It's also not difficult because I don't have too much of these.

For the inherited condemned stocks, I watch the share price to see if there is any madness around. In a bull market, there are many. Fortunately, I have unloaded most of them.

I have opened up all my cards now but these got nothing to do with diversification. Btw, I completed my thesis in my blog...for those who couldn't sleep...ZZZzzz....and I also have another Allocation Theory.