Drop the crystal ball, stay diversified

The average diversified balanced portfolio returned 14.6 per cent after taxes and fees last calendar year and, while this was below the return from Australian shares, it shows the importance of diversification. Now is not the time to switch to last year’s best performing asset class, according to Shane Oliver.

Oliver, the head of investment strategy and chief economist for AMP Capital Investors, says in his latest newsletter to clients, that the returns from balanced funds should not be compared with equity markets on their own. Australian shares returned 23 per cent in the 12 months to December, which was one of the better returns of any major market, except Japan, which was up 40 per cent. “Numerous studies by psychologists have identified that people tend to play down uncertainty and project the current state of the world into the future,” he says. “The biggest lesson of the last few years is for investors to avoid the temptation to switch strategy after a period of underperformance or perceived recent better performance elsewhere.” Oliver says that investors made this mistake in 1999-2000 with a move to global shares, after which they underperformed dramatically, and then a move to cash or residential property around 2002-2003, after which they both underperformed. “Similarly, investors should avoid the temptation now to jump more heavily into more risky assets. The best approach is to adopt an appropriate diversified strategy and stick to it.” Oliver says that the best-performing asset class for the year ahead is never obvious and diversified funds don’t aim to be solely allocated to that asset class or to beat them. “The problem is that no-one knows with absolute certainty what will be the best asset class going forward. No-one has perfect foresight – although many of us like to kid ourselves that we do.” Best and Worst Performing Asset Class Year Best asset class / Worst asset class 1990 Aus bonds / Aus equities 1991 Aus equities / Unlisted property 1992 Global bonds / Unlisted property 1993 Aus equities / Unlisted property 1994 Unlisted property / Aus equities 1995 Global equities / Unlisted property 1996 Aus equities / cash 1997 Global equities / cash 1998 Global equities / cash 1999 Global equities / Aus listed property 2000 Aus listed property / Global equities 2001 Aus listed property / Global equities 2002 Aus listed property / Global equities 2003 Global listed prop / Global equities 2004 Global listed prop / cash 2005 Aus equities / cash (Source: datastream, AMP Capital Investors) Oliver points out that while diversified funds will allocate a greater exposure to the asset classes they think will perform best, they will only do this within limits because they are aware that they don’t have a crystal ball.