The Merits of International Diversification

Now that the year of the monkey has come and gone. It must be quite a relief to many investors and depositors alike. After winning big in 2003, the SET Index ended the year 2004 with a 13.5% decline, which made it the second worst performing market with China finishing last with a negative 15.4%. In a way it was hardly a surprise given the number of bad news that came out last year. Martial law was declared in January to control escalating violence in the deep south, then came the twin crises of birds flu and rising oil prices due to the Iraq conflict and to cap off the year, Phuket was devastated by Tsunami disaster in December. As for ordinary bank depositors, concerns about nonperforming loans in the financial sector also put a brake on rising interest rates even though, rates in the US have been steadily rising in 2004. All in all it has been a pretty miserable year for many of us. Scraping by on 1% deposit rate and a lousy stock market with continuing unrests around the world. So what can one do? You might ask. The answer is to diversify . In this issue of Investment Planning column, we will show you the way to kill two birds with one stone, so to speak. By diversifying offshore, it is possible to reduce overall portfolio risk and enhance return at the same time. Here's what you have to do.

Going back to the old saying about how not to keep all your eggs in one basket, investment diversification utilizes the same principle. By carefully dividing up your portfolio into different asset classes such as equity, bonds, property and cash, the overall risk of the portfolio is much reduced since it will be highly unlikely that all asset classes will perform poorly at the same time. By using the performance of mutual funds as a case in point,

(Table 1 ) according to Lipper, a fund rating agency, most mutual funds had a bad year in 2004, losing an average of 3% during the year. Equity funds, which yielded more than 121% the year before, became the worst performers in 2004, down on average 7.09%. Balanced and flexible portfolio funds also lost grounds with negative 4.01% and 3.42% return respectively. Fixed income funds, on the other hand, registered small gains, with the general fixed income and short term funds returning 1.47% and 0.90%, while the relatively smaller money market sector grew a modest 0.77% underperforming the one year fixed deposit rate of 1% offered by Thai banks. As one can see that by diversifying one's portfolio across equity, fixed income and cash, what would have been a terrible year in the stock market will be less painful because of some small returns from the fixed income funds. However, getting by on 1.4% a year will not make you a millionaire, therefore, it is time to venture offshore to find greener pastures. (Table 2 )

Although, this is a major step for many of us but it is one worth taking. The one thing one has to come to terms with reality of life is that stock market in Thailand is still an emerging or developing market. Therefore, volatility will be high. One year the market is up 120% and the next it is down 15%, hence historical standard deviation is on a high side of 40%++, which makes it really difficult to predict the future with any accuracy. On the fixed income side, several Thai banks are still reeling from the bad loan crisis in 1997 with an average of 14% NPL on their books. Therefore, the whole market is still awash with liquidity and banks are still reluctant to lend. As a result, low interest rates environment will be here for may more years and no one can tell for sure when bank deposit rates will be back to the level of 5-6% that we are accustomed to.

This is a compelling reason to invest offshore in order to enhance portfolio return and reduce risk at the same. Understandably, many of you will be afraid of the unknown such as currency and investment risks. Then, there's the asset allocation decisions to ponder: how much to go offshore? Which country or region for that matter? And lastly, there is the tricky question about foreign remittance i.e. how to get money offshore legally! An easy answer to all of the above questions is to get in touch with a qualified Investment Planner (IP) or Certified Investment Advisor Representative (CIAR). He or she will be able to walk you through the various steps of investing overseas but for most of us the good news is that now one can invest offshore legally via the specially designated Foreign Investment Funds (FIF).

These funds are professionally managed by qualified and pre-selected fund houses. Moreover, there are several asset classes available ranging from plain global equity funds, Asian bonds, convertible bonds to balanced funds. Currently, there are only 5 FIF available but the SEC will allow more funds to be sold to the public in the near future. According to Lipper, the best performing funds for 2004 belonged the FIF sector, which gained 10.46% in 2004 and 12.61% in 2003.

The year 2004 is a classic example for going offshore, with some of the local equity funds with a negative return of 28%! And most of the FIFs yielding double digits return (8.71% to 12.12%), you don't need to be a rocket scientist to figure out why international diversification helps enhance portfolio return and reduce risk at the same time.

What the future holds for Thailand in the year of the Chicken is hard to tell. Land -slide election victory for TRT has given the PM a clear mandate to move ahead with much needed economic reforms and infrastructure investment. The BOT has forecasted that the kingdom's GDP for 2005 will be around 5.5-6.5%. On the negative side, political unrests in the South still persist, subsidy of diesel fuel will be lifted and uncertain economic outlook will mean that it is worthwhile to take out some sort of a portfolio insurance by investing offshore via FIFs.