The changing shape of a diversified portfolio
A diversifed portfolio in the 21st century will be much different to what was used in the 1990s, WestpacTrust chief investment officer David Beattie says.
Wednesday, April 5th 2000, 12:00AM
Instead of having a portfolio full of "me-too", vanilla type funds, where one looks little different to another, there will be a wide variety of innovative new products.
Beattie, speaking at a BIIA funds management conference, says there major shifts going on in portfolio construction are due to the changing market place, especially with the growing globalisation of markets.
One of the trends which has been evident in recent years is the shift towards having a greater proportion of international assets in a portfolio.
This reflects the fact that the New Zealand market is tiny on a global basis and makes up less than one per cent of the world's share market capitalisation.
Beattie says this trend is likely to accelerate and the local market will become almost irrelevant in the equity and fixed interest parts of a portfolio.
"Over the next five years I would not be surprised to see the New Zealand equity asset class comprising as little as five per cent of a total portfolio."
What's more he doesn't hold out a lot of hope for the survival of the New Zealand market as a separate entity in either the cash or the bonds.
He thinks that the New Zealand sharemarket will become part of the Australian market, and investors will get exposure to New Zealand companies through offering such as AMP Asset Management's Private Capital Fund, which invests in unlisted companies and venture capital funds.
The other possibility is that competing markets will be established for trading securities, as opposed to the traditional stock exchange.
His outlook for the New Zealand fixed interest market isn't that flash either: "It is also likely that a single fixed interest asset class will be the norm, with New Zealand and international fixed interest sectors no longer treated as two distinct asset classes."
The reason for this change is that the New Zealand fixed interest market lacks depth and there are very few quality corporate offerings available.
This was highlighted by several National Bank of Australia executives who were in New Zealand recently promoting an "alternative" Australian fixed interest fund which invested in Australian corporate debt.
While buying shares directly is popular, especially in the New Zealand and to a lesser degree the Australian market, New Zealanders hold the bulk of their offshore shares through some sort of managed fund, whether it be based in New Zealand, Australia, or the United Kingdom.
Most of these funds are run on a global basis, managed offshore, and make their investment decisions based on geographical boundaries.
The new look funds are more than likely to be invested along the lines of industry sectors, rather than country.
With the freeing up of global capital flows, accessibility of cheap global labour pools, a decline in trade barriers, and the burgeoning internet, country investment boundaries are becoming significantly less important when it comes to analysing investment opportunities.
"Global industry prospects will become more important factors in determining international investment strategies, and the actual country weights tend to drop out as residual," he says.
In the United States this trend is definitely in the ascendancy, and there are signs it is starting to occur here. Three managers, BT Funds Management, Calan Healthcare and Invesco, are either offering, or about to offer sector funds to New Zealanders and other managers are likely to follow suit.
Beattie says the trend for sector funds is being embraced by sharebrokers, who now organise their teams by sector, and in the indices themselves.
While the MSCI, which is calculated by country, is the standard benchmark for international shares, the people who devise this and other indices are now creating sectorial ones.
Derivatives used to lower risk
The other major trend which is likely to play a critical role in the investment portfolio of the 21st Century is use of derivatives such as hedge funds. While such funds have had bad press through the likes of Nick Lesson and Barings Bank, and the failed LTCM fund, they are playing an increasing useful role in wealth creation.
"Although not well understood and at times maligned, hedge funds are nevertheless a good example of the endless potential made possible by highly liquid derivatives markets, particularly the ability to short sell," Beattie says.
"With many standard asset classes having arguably become more commoditised, future initiatives will centre on using these asset classes as the basis for innovative product offerings," Beattie says.
Currently not many hedge or derivative funds are being offered to New Zealand investors. However, the two which are actively being promoted have been successful. One is the Tower Multi-Trading fund which is run by well-renowned international manager GAM, the other is the OM-IP series of funds which are promoted by sharebrokers Ord Minnett.
The OM-IP fund is an unusual product in that it is both a capital guaranteed product and a hedge fund. Part of the money is invested in bonds so the promoters can pay investors their full initial investment at maturity, the balance is then given invested with a hedge manager.
"As acceptance for derivatives increases, so derivatives-based products are more likely to become the norm for investors."
Beattie says the emergence of these new types of investment are also a challenge for investors and their advisers in terms of portfolio construction.
He says tools, such as sector funds have to be built into a long-term strategic asset allocation, as opposed to being used for tactical short term trading.
His view is that many people are using sector funds, most notably technology funds, as short term, flavour of the month investments.
"They have to be dealt with strategically," he says. "Not enough emphasis is being put on strategic asset allocation.
What does the portfolio of the 21st century mean in terms of risk and return?
"Oh dear that's the $64 million question," Beattie says.
"The new assets or more innovative approach to portfolios is being done to outperform the traditional asset classes."
He says investors need to understand that the double-digit returns of the 1990s aren't likely to continue forever, and expectations need to be lowered.
"Markets are going to struggle to get double digit returns in the next 5-10 years," he says.
Part of the reason for this is that the bull run in the United States market is the longest ever, and it is thought to be in its late stages.
Beattie says when the cycle changes investors will need to take quite a different approach to investing and other products such as index linked bonds and options strategies become more effective.
While returns will be lower the amount of risk will also fall, especially in portfolios which use derivatives.
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