Tuesday, November 29, 2011

Investing offshore for added diversification

DIVERSIFICATION is an investment principle that seeks to reduce risks by investing in a wide range of investments and asset classes.

In this article, we show how unit trust investors can diversify their investments with offshore equity funds as part of their portfolios.

The principle of diversification is not to put all your eggs in one basket. In investment terms, this refers to a method of reducing risk through spreading your investments across several markets, sectors or asset classes.

Offshore investing is an effective strategy for investors to protect their portfolios from the potential downside of a single market as well as a means to enhance their potential returns.

Diversifying into foreign equities can help to reduce portfolio risk because different markets and economies move in different cycles.

Therefore, by investing in various markets instead of a single market, investors can reduce the impact of country- or region-specific risks.

This is particularly true in the case of regional markets which comprise a spectrum of fast growing emerging countries and developed countries.

Benefits of investing in offshore markets

The main benefit of investing in offshore markets is that investors will be able to capitalise on the growth potential of offshore markets.

In addition, investors will have access to a wider universe of quality companies to invest in. These companies range from well-established regional companies which have strong market shares in their respective markets as well as emerging companies which have strong growth potential.

Due to the comparatively large market capitalisations of many internationally listed companies, investing in offshore markets also enables investors to benefit from higher levels of liquidity when trading in securities.

Given that stock market cycles of different markets are generally volatile and unpredictable, unit trust investors are advised to diversify across a number of markets which offer a wide universe of stocks.

The full benefits of diversification are achieved when the movements of different markets are not perfectly correlated with one another.

However, before considering the type of offshore funds to invest in, unit trust investors should determine their appropriate asset allocation based on their respective risk profiles, investment objectives and financial needs.

Be aware of the risks

Investors who venture into offshore funds should be aware of the various risks which their investment may be exposed to. These risks include the following:

* Market risks

The purchase of equities represents a risk since the prices of stocks underlying the NAV of the fund fluctuate in response to many factors, such as the activities of individual companies and general market or economic conditions.

* Liquidity risk

Liquidity risk is defined as the ease with which a security can be sold at or near its fair value depending on the volume traded on the market. If a unit trust fund has a large portfolio of securities that are less liquid or difficult to sell, the securities may be sold at a discount to its fair value, hence affecting the value of the unit trust fund.

* Currency risk

Where a percentage of the value of a fund is invested in foreign currency or assets denominated in foreign currency, the value may be exposed to currency fluctuation risks.

Fluctuations in foreign exchange rates will affect the value of the fund's foreign investments upon conversion to local currency and subsequently impact the value of the unitholders' investments.

* Country risk

Overseas investment of the fund may be affected by changes in the political and economic conditions of the country in which investments are made. Such political and economic factors may influence the growth and development of business enterprises and impact the stock prices of listed companies.

Offshore funds help to diversify your portfolio.

In general, a diversified investment portfolio comprising investments in local and regional markets can achieve potentially higher returns than a portfolio that is concentrated in a single market. This is because markets do not move together due to differences in liquidity conditions, economic structure and corporate earnings prospects.

A well-managed diversified portfolio comprising local and regional equities can also lead to enhanced returns as markets with stronger growth prospects are overweighted and markets with slower growth potential are underweighted.

Conclusion

Diversification into offshore markets provides the opportunity to participate in the long-term growth prospects of regional markets.

However, it is imperative that you understand the risks involved before you spread your investments internationally.

Investing for the long term and applying ringgit-cost averaging for your investments may help investors to mitigate some of the risks of investing in offshore markets.

This article is contributed by Public Mutual Berhad @ Business Time

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