‘Portfolio diversification more important now’
Premium- According to the report, investors from smaller and emerging markets have more to gain from global diversification
The Credit Suisse Global Investment Returns Yearbook 2022 has made ‘diversification’ this year’s focus topic. The yearbook highlights that diversification across stocks, countries, and assets reduces risk. Investors in all countries can earn the same return with lower risk or a higher return for the same risk.
At a juncture when there is an uptick in volatility, continued rise in inflation, and the prospect of a rate hike cycle, Credit Suisse believes that it is more important now than ever to review portfolio diversification.
International investing
In terms of international diversification, the report points out that globalization has increased to the extent that markets move together and lowers the potential risk reduction. “However, the benefits remain large but not guaranteed," states the yearbook.
Global diversification can be oversold, however, if it is presented as a sure-fire route to a superior return-risk trade-off, observed the report. “We have seen that over the last 50 years, global investment led to higher Sharpe ratios than domestic investment in the vast majority of countries," as per the report. For starters, the Sharpe ratio indicates the risk-adjusted returns of a portfolio.
Pointing to the average correlation between developed markets and emerging markets, the yearbook stated that despite increasing correlation, the potential diversification gains are still large. Investors from smaller and emerging markets have more to gain from global diversification than those from developed markets. “Smaller countries often have concentrated stock markets that are dependent on a small number of business activities. Their stock markets are concentrated not only by company but also by sector."
In a separate country-specific report, the firm stated that in India, technology accounts for 19% of the market capitalization of the FTSE World India index, while financials account for 19% and industrials for 12%. The largest companies are also highlighted with reference to Reliance Industries Ltd. (10% of the index), followed by Infosys Ltd (8%), Housing Development Finance Corporation Ltd (6%), and Tata Consultancy Services Ltd (5%).
The report also said that the investors should not be misled by claims that only 10-20 stocks are needed for a diversified portfolio.
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