Portfolio diversification, Financial Management

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Portfolio Diversification

The objectives of diversification are to:

  • Reduce the variability of the fund's total return;
  • Reduce the exposure to any single component of the capital market;
  • Reduce the risk of returns not tracking or exceeding inflation;
  • Increase the longer-term risk-adjusted return potential of the fund.

To achieve diversification, the fund will invest in the various categories of assets classes viz., equity shares, debentures, government securities, etc. In most countries, portfolio diversification is subject to the regulations of the local government.

Selecting the Asset Classes

In any investment management system, once the objectives of the investment are set-up, the investor has to focus on the asset classes to invest. The resulting assets of a pension fund must be invested in such a way that the "value creation" goals for the business are most likely met. Capital market investment is one of the key investment vehicles for the pension funds around the world, though they have very unpredictable movements. This study includes current levels of stock and bond indices, their historical changes, inflation projections and also studies of the real estate values. Hence, the capital market expectations play a crucial role in setting the choice of asset classes.

 


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Mike Dever

9/11/2012 12:27:35 PM

While portfolio diversification is the one true "Free Lunch" of investing, if a person starts with just considering long stocks, bonds, commodities and real estate as being the only portfolio options, then true diversification cannot be achieved. That is because conventional portfolio diversification is constrained by the use of "Asset Classes." I discuss this throughout my book, which is the #1 best-selling mutual fund book on the Amazon Kindle.

My approach to diversification is quite different from conventional investment wisdom. One concept I think you'll find most interesting is in that I replace asset classes with "return drivers" and "trading strategies" (as I point out in the book, asset classes are simply long-only trading strategies that do not attempt to disaggregate their many separate return drivers). Once viewed in this fashion it is easy to create a truly diversified portfolio, rather than one constrained by the shackles of asset classes.

I'm pleased to provide a complimentary link to the final chapter of the book, where I present the benefits (greater returns & less risk) of a truly diversified portfolio: http://bit.ly/vxDo6v.

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