Are You Diversified?

Tab 1

Summer 2013

It may be human nature to flee from danger and rush to safety. But that instinct shouldn’t necessarily apply to your investments, as feelings don’t always equal facts.


True, events like the 2000 dot-com bubble burst or the 2008 market crash can be nerve-wrackingfor even the most confident investors. But it’s best not to make any rash decisions — eliminating an entire asset class from a portfolio,

for example — during times like these, says Rob Haworth, Senior Investment Strat­egist for The Private Client Reserve.


A better solution might be reducing exposure to a certain struggling asset class while maintaining portfolio diver­sity — then over time and as the mar­ket rebounds, slowly rebalancing that exposure until it’s back in line with orig­inal goals.. Portfolio diversification and strategic adjustments become especially pertinent during tough economic times when short-term emotional decisions can have long-term financial consequences.


U.S. Bank concentrates on four cap­ital markets — equities, fixed income, real estate and commodities — then leverages all types of appropriate asset categories within these four markets. Understanding how each specific asset class is potentially affected by market changes may help you make wise deci­sions about selecting investments and making adjustments when necessary.


The dos and don'ts of diversification

Tab 2

Summer 2013

Equities: Think Globally

When it comes to equities, we believe global diversity is incredibly import­ant, says John M. De Clue, Chief Investment Officer of The Private Client Reserve. The U.S. market represents just 38 percent of the global equities market, and global indices such as Japan’s Nikkei (an average of Japanese equities that is an unmanaged index not avail­able for investment) are currently soaring. “Major equity stocks trade outside the United States, so if you aren’t investing globally, you might be missing opportunities to potentially benefit your portfolio.”


Equities: Investing globally might be a benefit to your portfolio.


Of course, you can have greater risk and volatility related to economic and business developments with equities.


Despite that, global equities invest­ing can be difficult for some investors to embrace, especially in the current economy. China’sgrowth has slowed, the Eurozone crisis has made some investors skittish, and emerging markets — once touted as the hot destination for investors — have not performed as well as expected in recent years.

But even in regions doing poorly, there might be opportunities, Haworth says. While in the short term the European Union still looks risky to us, over the next two to three years there may be plenty of compelling investment opportunities, says Clay Webb, Head of Asset Allocation at The Private Client Reserve. “Things can change very quickly,” he says.


Of course, past performance is not a guarantee of future results. Plus, international and emerging markets involve greater risks: for example, foreign taxation and currency risks, and the potential for greater volatility, especially if you concentrate in a region.


For investors who are still wary of the inter­national marketplace, well-recognized companies based overseas might be an easy way to gain diver­sity. “There are many oil companies, food product companies and tech companies to choose from,” De Clue says. “Don’t deny yourself the opportunity to look at these stocks.”

Tab 3

Summer 2013

Fixed Income: Don't Write It Off

The past few years have seen record inflows into bonds, possibly as a result of recession-driven stock-market fears. In 2012 alone, investors added more than $90 billion to bonds while pulling more than $150 billion from stocks, according to fund flow tracking firm EPFR Global.


Fixed Income: Don’t be quick to eliminate exposure to bonds altogether. Rather, consider bonds with shorter maturity dates as well as municipal bonds.


Some investors are wary of fixed-income investments because they believe we’re at the end of a three-decade-long bull market for bonds, De Clue says. In late June, the yield on the 10-year U.S. Treasury note was at 2.52 percent, down from around 5 percent just five years ago.


Even though bonds carry their own set of uniquerisks, it may not be wise to eliminate exposure to bonds altogether, or even dramatically reduce the percent­age outside the range of the portfolio’s targeted goals.

An investor may consider underweighting his or her exposure and, in the case of 10-year Treasury notes, consider bonds with shorter maturity dates to potentially reduce risks, De Clue says.


Fixed-income investments typically decrease in value when interest rates rise. This risk is greater in longer-term bonds. Municipal bonds, for example, still may be attractive because of their tax-exempt status and current high yields (see“Munis: Reading Beyond the Headlines”).


In addition, investing in emerging-market debt may be compelling, Haworth says, although there may be other risk factors to consider. Rates in developing nations are down, gross domestic prod­uct is increasing and there is tremendous demand for cash.


“If we look ahead, the long-term trends around emerging-market debt as a fixed-income investment appear promising,” he says. “Investors may benefit from the economic growth and relative creditwor­thiness of these growing economies, which can lead to higher yields.”

Tab 4

Summer 2013

Real Estate: Time for Reconsideration 

Many investors shied away from real estate when the bubble burst in 2008, dramatically lowering their exposure to this asset class. “Investors may now want to reconsider,” says Ed Cowling, Director of Specialty Assets for The Private Client Reserve. “The real estate market went down, but it’s come back a long way from those lows as economy fun­damentals have strengthened,” he says. “While past performance is no guarantee of future results, if you are not consider­ing some exposure to real estate, you might be missing an opportunity.”


Real Estate: If you shied away from real estate when the bubble burst in 2008, it might be time to reconsider.

Real estate investments may help balance your portfolio because they may provide growth potential and an income source, and historically have been low to negatively correlated to equities markets, Cowling says.


Real Estate Investment Trusts (REITs) have been especially strong in the current market. “They have been increasing in value since the recession,” Cowling says.

However, an April 2013 survey from the Urban Land Institute and Ernst & Young predicts that returns for REITs will decrease a bit, from 12 percent in 2013 to 10 percent in 2014.


By diversifying across various sectors, investors may be able to stagger their returns to help generate what we call “steady value.”


For example, investments focused in apartments were the first to regain value, so these investments are further into their recovery cycle, while the tim­ber and healthcare sectors continue to gain momen­tum, and investments in office buildings are just beginning to come back.


“We believe office space may see the highest run over the long term, but returns could take five to 10 years or longer,” Cowling says.


He also encourages investors to consider diver­sifying their real estate investments across regions. New York, Los Angeles and Chicago hold a lot of promise, but as the economy returns, secondary markets are gaining favor with good investment return. Internationally, we believe some cities in Asia are the most attractive because of increasing urban populations and a growing middle class.


Real estate investments are not without risk, however. They can be subject to fluctuations in the value of the underlying properties, the effect of eco­nomic conditions on real estate values, changes in interest rates and risks related to renting properties.

Tab 5

Summer 2013

Commodities: Potentially Balance Risk

Commodities are another useful tool to mitigate risk, particularly relating to inflation shock that can occur with international crises, Haworth says. Whether there’s a drought in the United States or fears about the nuclear threat in North Korea, commodities are priced on the global market so they help balance the risk. “That’s an important function you can’t get from other asset classes,” he says.


Commodities: By investing in commodities, you might be able to mitigate the risk of inflation shock as a result of international crises.


Because pricing doesn’t vary geographically, itmay not be as important to invest in international commodities markets. 

However, Haworth does suggest holding com­modities from a range of sectors, including metals, agriculture and energy. “We recommend a good allocation to energy, and petroleum in particular,” he says, adding that, currently, overweighting gold might not be a wise investment.


As with all asset classes, balance is key. “We believe the commodities market likely will see some appreciation this year, although it won’t likely be a bull market. So it might be a good time to maintain a neutral stance,” Haworth says.


Commodities markets also see a lot of change over the long run, and investors should keep that in mind when making decisions. “It’s a hard cate­gory to predict,” Haworth says.


They also can be at risk of market price fluctu­ations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors.

Tab 6

Summer 2013

Rebalancing Act

Occasional changes to your identified asset allo­cation might help ensure your portfolio stays in line with your long-term investment goals, as well as potentially generate incremental improvements in profitability.


Investors may consider reassessing their asset allocation when there is a dramatic market shift. When such assessments result in a potentially over- or underweighting within an asset class in response to market shifts, investors should revisit the portfolio as the market rebounds with an eye on rebalancing the allocations back in line with original goals.

“If you are fortunate enough to see the stocks in your portfolio appreciate significantly beyond your target, it’s important to think about when you will rebalance back to your target to lock in gains,” De Clue says.


While there are no guarantees of profitability or protection against loss, maintaining a diverse and balanced portfolio is one way to potentially min­imize risk and achieve long-term financial goals. Every person’s situation is unique, though, and what is appropriate for some investors may not be appropriate for all. Talk to your portfolio manager to help determine what is right for you.


“It’s about achieving your objectives for the future and making a longer-term plan for 10, 20 years, etc.” Webb says. “Staying true to your objec­tives and maintaining some exposure in several asset classes may be a way to help smooth out the bumps along the way.”


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