Junk Status: Diversification is key to protect against market shocks

The best thing you can do during periods of heightened uncertainty is to stick to your investment plan.

It is in times like these that investors need to hold on to a diversified and long-term investment strategy. Even as a political storm is once again battering South Africa, history has shown that, in the long-term, markets have the ability to return to fundamentals even when short-term noise, especially from the political sphere, creates much angst.

The recent downgrade of South Africa’s investment grade status to junk by more than one international ratings agency has highlighted the importance of having a diversified investment portfolio.

If you have chosen the right fund with a long-term track record of performing through the cycles, or created a portfolio that is well-diversified across currencies and asset classes, do not panic. A diversified portfolio limits the risk of permanent capital loss, but still maximises the probability of real returns.

Guard against investing based on news headlines

It is worthwhile reviewing your portfolio from time to time, but caution against making investment decisions in reaction to market news and movements.

While it is clear that we are currently in a period of uncertainty try to remain calm, tune out the market noise, and continue investing in line with your objectives and risk tolerance. If you second guess your investment strategy based on short-term news, you can end up destroying a lot of value.

Note that in many cases experienced investment managers would have already geared for potential market shocks in their funds.

The importance of ongoing offshore exposure

If your portfolio includes holdings in well-diversified businesses whose earnings are generated offshore and not in South Africa, there is a good chance that the fund you are invested in is well-positioned to withstand negative market sentiment, such as with a downgrade. A well-diversified portfolio should include offshore investment.

In the past South African investors have flocked offshore in response to rand weakness. This is counterintuitive and expensive.

A better solution is to appreciate ongoing diversification across asset classes, for example by investing in a balanced fund, and not try to time currency movements.

Opportunities at home should not be discounted. Many solid local businesses have proven that they can withstand market shocks. If their share prices are impacted by a widespread sell-off of domestic assets, this could present a good investment opportunity.

It is critical for investors to ensure that their investment managers continually reassess risks and potential returns as circumstances change; making appropriate portfolio changes over time. This is the key to ensuring that your capital is protected against permanent loss during periods of under-performance and market uncertainty, both of which are inevitable.