Diversify your portfolio to weather the storms

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Gloomy ... 2011 was a shocker for equities, when they posted a loss of 15.18 per cent. Photo: Stuart Walmsley

The concentration of many people’s superannuation in equities and low exposure to fixed income is becoming well known. Adding some fixed income to a portfolio steeped in equities is a good way to smooth out overall returns.

There is no escaping that 2011 was a shocker for equities with a loss of 15.18 per cent. Meanwhile government bonds had an excellent year with a 20.15 per cent return.

Body of evidence

While past performance is no great pointer to what is to come, there is growing evidence to suggest having both equities and fixed income is better than betting on one or the other.

FIIG Securities says while the differential in 2011 was abnormally large, the opposing returns are intuitive.

When the economy looks stretched and negative sentiment prevails, equities typically decline. A poor environment for equities coincides with falling interest rates and flight to quality and movement of funds into low risk assets.

This generally means a rise in the value of fixed-rate assets, particularly long-dated government bonds and a slump in equities.

Bonds rise in value when yields/interest rates fall. By mixing up a portfolio with some fixed-interest investments like bonds, say 50/50, the 2011 year could have resulted in a much more palatable return of 4.97 per cent.

Rule of thumb

FIIG Securities’ director of strategy and market development, Stephen Nash, says one rule of thumb for investing is to allocate your age as the percentage of fixed income in your portfolio.

So if you are 65 years old, invest 65 per cent in fixed income. Applying this to a simple portfolio of fixed income investments ranging from government bonds to listed hybrid securities (a mix of debt and equity) and equities, the 2011 return could have been a more respectable 7 to 8 per cent.

If staying invested in equities is part of your mantra, then diversification across different sectors is equally important.

HSBC Bank’s Mike Danby says it is worth remembering that since the GFC, unlike many governments and consumers, companies have been managing prudently. “While the former were building debt to unsustainable levels, companies were paying down borrowing and building cash balances. Equity dividend yields stand at attractive levels compared with government bonds, while company balance sheets are enabling them to grow dividends which is very attractive in a low-interest-rate environment.”

A good example

Prescott Securities financial adviser David Middleton’s suggestion for a diversified share portfolio (as at January 2012) with a total yield of 7 to 9 per cent is spread across banking, financial services, engineering, retailing, telecommunications, healthcare, and insurance.

More specifically (again as at January 2012) the three big banks, National Australia Bank, Westpac and ANZ have low price-earnings ratios and average anticipated yield of more than 7 per cent fully franked; ASX for when shares become interesting again but in the meantime there is an expected 6 per cent yield fully franked; engineering construction company UGL; Metcash for staples and retailing; Telstra as a beneficiary of the NBN with a clearer future and good leadership; Sonic Healthcare for health care exposure; Perpetual for its leverage to market movements; and QBE, a well and conservatively managed insurance company.

NB: In times of economic uncertainty it’s also wise to take another look at your investments, and especially whether you are looking for investment or growth.