Too many different strategies in multimarket and equity funds can be detrimental to the good performance of portfolios.Most asset managers say they prefer investments in companies that have a simple business model. This is because, in this way, they are able to better understand the company, more confidently predict potential gains and anticipate possible losses when buying that stock.
Investors in mutual fund shares can also follow the advice of professional managers and exercise caution with overly complex portfolios. Diversification reduces risk, but overdoing the fund’s positions can also cause unexpected negative surprises.
Carl Richards is an investment adviser who became famous for delivering sophisticated messages through simple drawings, in the form of doodles on a paper napkin. One of the most popular sketches is a picture in which the word risk appears inside a rectangle, next to the word uncertainty surrounded by a cloud.
The idea is to explain that risk is something that we can define, identify and measure. It would be as if you could keep it inside a box, with well-defined limitations.
For example, when you invest in a car rental company, you know that the business’s income depends on the rental of the fleet and the sale of used vehicles. If the revenue is greater than the operating and financial costs, the venture will make a profit.
Uncertainty is associated with unforeseen factors. Hence, the image of the cloud, which can fall apart at any time.Imagine that you decided to start an e-commerce, but you were surprised by the amount of fraud and purchase returns. The business can end up with a lack of experience and ignorance of operational nuances.
There are businesses that are inherently complex. The operation of an airline is an example.
In addition to the income being seasonal, the costs vary depending on the price of fuel, the fluctuation of the currencies of the countries where the company operates and the weather conditions. As well known as these risks are, on many occasions an adverse combination of several factors can seriously affect the financial health of the company.
With the reduction in the difference between financial gains in Brazil and abroad, many investment fund managers have aggressively started to build positions in the international market. In fact, globalization has made it possible for purchase orders given here in the country to be executed instantly.
Access to the global market for resource managers is virtually unlimited. As a result, today the portfolio of hedge funds and equity funds are filled with foreign securities. These are operations with fixed income securities, shares and derivatives in several currencies.
This greater diversification reduces risk. Theory demonstrates, and practice proves, that the combination of investments that are not correlated with each other is more likely to produce results with a greater relationship between risk and return.For investment funds, it means more income with the same share fluctuation. The caveat is that this occurs if there are no unforeseen events, which are called “unknowns” in market jargon.
The current economic crisis caused by the new coronavirus pandemic has revealed many unknowns. Nobody knows for sure what the supply and demand for corporate spaces will look like, if consumers will definitely migrate to e-commerce or if the big tech companies will get even bigger.The consequence is that there is no way to predict which segments of the economy will have greater profitability from now on. Given the uncertainty, diversification seems to be a prudent move.
However, it is important not to overdo it. It is safest to invest with managers who have a simple and easy-to-understand investment process.