Diversification is a key risk management tool, and investment funds themselves offer the easiest way to diversify investments because they involve a much higher volume of assets under management and a larger number of securities compared to a portfolio held by a private investor. Because they invest the fund's assets in as broad a spectrum of securities as possible, a fund generally involves a lower risk than investing in a single security, and fund managers will tailor the level of diversification of the fund's portfolio to its performance goals and the risk profile 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:
By investing in a mix of asset classes investors can simultaneously participate in the growth potential of shares, the regular income and relatively stable price offered by bonds and the liquidity of cash and money market instruments. Fund managers may also seek further diversification within a particular asset class – for example through a combination of secure but low-yielding government bonds and corporate bonds, which pay higher interest but carry a higher risk of default. Diversification within an equity fund might include the shares of consistently profitable blue-chip firms alongside stakes in riskier but potentially highly profitable start-up companies.
Investment funds can invest in securities from a variety of countries or regions where different economic conditions are in place, which in turn influence security prices. For instance, share prices of companies in countries that are on the path toward industrialisation (the "emerging markets") frequently show a stronger and more rapid increase than the shares of companies from economically mature regions, but in exchange experience larger fluctuations in value. However a globally diversified portfolio can offer access to potentially higher-yielding assets while maintaining the stability of a broadly diversified base. This is because, at times of global economic turbulence, geographic diversification may protect investors if certain regions of the world – and thus the prices of securities from those regions – recover more quickly than others.
Investment specialists usually divide a country’s economy into a number of industry branches, known as "sectors", which include areas such 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. Investment funds can focus on certain sectors within a country, a region or throughout the world. Fund managers that invest in some or many sectors of an economy try to identify sectors that are likely to thrive while avoiding other sectors or underweighting them in their investments (shares, bonds, money market securities).