Diversification
Diversification is a key risk management tool, and investment funds themselves offer the easiest way to diversify investments because of the volume of assets they hold compared to that of an individual's portfolio. Funds can be diversified by region, sector or asset type and many funds will invest in a wide variety of different assets. Spreading the risk across as wide a spectrum of securities as possible should make a fund less vulnerable to market downturns. Fund managers will tailor the level of diversification of a fund's assets to its performance goals and the risk appetite of its investors. In general, investors with a lower risk appetite will seek out more diversified funds, while those willing to shoulder greater risk may prefer to invest in funds whose investments are more concentrated in a particular area. Diversification usually falls into three key categories:
Region
Different countries or geographic regions across the world offer different economic environments. Generally, the share prices of companies in rapidly industrialising countries often grow more quickly than those in more mature regions. As a general rule, emerging market economies see more price volatility than mature ones. However a globally diversified portfolio can offer access to higher-yielding assets while retaining the stability of a broadly diversified base.
At times of global economic turbulence, geographical diversification may protect investors if certain parts of the world recover more quickly while others are still shaking off the impact of credit restrictions or economic recession.
Sector
A country's economy is usually divided by investment specialists into a number of industry groups known as sectors that include such areas as manufacturing, telecommunications, healthcare, technology and financial services. The overall performance of each sector can be measured by an index that reflects the sector's economic strength. While investment funds can invest across the whole economy of a country, region or even the world, they can also focus specifically on particular sectors. Managers of funds that invest in the economy as a whole will try to identify sectors likely to thrive and avoid those sectors that might not enjoy the same level of success.
Asset type
By investing in a mix of asset types you can gain access simultaneously to the growth potential of equities, the regular income and relatively stable price of bonds and the liquidity of cash. Fund managers may also seek further diversification within a particular asset class itself – for example a combination of secure but low-yielding government treasury bonds and bonds from companies that pay a higher interest rate but carry a higher risk of default. Diversification within an equity fund might include the shares of steadily profitable blue-chip firms alongside stakes in riskier but potentially highly profitable start-up companies.