Retail investments are generally composed of a number of asset types. The level of risk tolerance between one investor and another differs, not only the composition of portfolios but also the diversity in terms of asset allocation, asset type selection as well as maturity profile of underlying investments will characterise a portfolio and make it distinct from any other portfolio.
In addition to investments such as equities, bonds, money market instruments and/or foreign currency, the investor’s overall portfolio might also include investments/exposures to pension funds, life insurance policies with a savings element embedded in them, and others.
The returns on high yield bonds are generally less volatile than those on equities, and over recent years, there has been a strong relationship (correlation) in their returns
Investors must be aware of the correlations between the returns of different assets, and how such returns behave during differing market conditions when evaluating the risk of a portfolio. For example, the returns on high yield bonds are generally less volatile than those on equities, and over recent years, there has been a strong relationship (correlation) in their returns. On the other hand, there is a weak relationship between returns on high yield bonds for instance and the returns on the ultra-high grade sovereign bonds, such as the German Bund.
When viewed as part of a portfolio and not in isolation, the offsetting pattern (or weak relationship) of returns on these two assets serves to stabilise the risk of the overall portfolio. Investing in assets with payoffs which are inversely related is called hedging and is one of the key contributors to reducing overall portfolio risk. An insurance contract could be viewed as such. Another form of indirect hedging instrument within a portfolio is gold. Historically, the price of gold and equity markets have had very low correlation. However, equity investors might have in the past wished to have been exposed to gold in their portfolios in an attempt to reduce overall risk.
Another way to reduce overall portfolio risk is by means of asset diversification. Retail investors are generally guided to spread their risk by investing in a wide variety of assets so that exposure to the risk of any particular security is limited and that the performance of that one security does not materially impact (in either a positive or negative way) the overall performance of a portfolio.
Asset managers constantly strive to achieve the optimal risky portfolio not only by delving deep into the macroeconomics of global capital markets and through a thorough stock selection process, but also by using mathematical and statistical tools such as the concept of co-variance of asset returns in their day-to-day as well as medium-term asset allocation decision-making process.
Disclaimer:
This article was issued by Mark Vella, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.