Untitled Document ADD BONDS TO A
What did you do when you were interested in 'hot markets' such as India and China? Did you actually go through the trouble of asking your investment advisor what you should do or did you just invest more and more into single country funds? Many investors often get carried away when investing in markets that they like. Not knowingly, most of their money goes into single country funds. Thus, they end up with a 'gung-ho' portfolio full of single country funds. Markets fall and rise as investor sentiment wavers. So what should you do if you are already invested into single country funds but feel threatened by their volatility?
Our answer to 'soften' this kind of gung-ho portfolio is simple. All you need do is diversify by investing into bonds. Many investors become so excited when they purchase single country funds that they often forget the importance of diversification. Last year Asian markets did well. The MSCI Asia excluding Japan index went up by 40% in 2003. During this period, many investors focused on buying single country funds. Funds investing in China, India and Thailand were very popular. While performances in some of the single country markets may have been very strong, it is important for investors to note that the best performing market in the past year, may not be the top performer in the following year. While valuations and projected earnings may still be attractive, these single country markets are still very volatile.
By now, some investors might be thinking of selling off their some of their single country equity funds and lamenting that they should have diversified. Others might see the longer-term potential of investing in these funds and may want to stay invested. In either case, adding bonds to diversify this type of gung-ho portfolio, is a good idea. Let's say you are very bullish on single country funds such as India and China and you do not want to invest into the growth of the other regions. What should you do?
You should consider minimizing the volatility of your portfolio by investing into bonds. Let us consider two scenarios. The first scenario occurs in good times and the second scenario in bad times. We made some assumptions on the returns for the two scenarios. From the two portfolios that exclude and include bonds, you can see that when markets go up, the no bonds single country portfolio will have a return of about 6% higher than the other portfolio. The loss for this portfolio will be -29.7%. However, if you adjust your portfolio by adding bonds with stable returns to your portfolio, the loss during 'bad times' will be lowered by about 8%.
For gung-ho investors that wish to reduce volatility, Singapore Governments Bonds (SGS bonds) are good alternatives. These bonds provide a stable coupon payment to buffer the losses when markets are volatile. In addition, the coupons paid are fixed, and thus provide a level of stability for a very aggressive portfolio. One suggestion is to review your portfolio and determine whether you are one of those that invested 'too aggressively' into single country funds (one hint will be if you have more than 75% in single country funds). If you are investing too much into single country funds, we suggest that get some exposure to bonds or bond funds to diversify your risk.
Mah Ching Cheng (Analyst and a licensed investment representative) is part of the Research and Editorial team at Fundsupermart, a division of iFAST Financial Pte Ltd.
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