Don't always bet on the same horse when investing

Twelve months ago, markets were in a dire state as they grappled with the aftermath of irresponsible subprime lending and the credit crisis that followed. Equity markets in mature economies, such as the USA, UK, Germany and France, had fallen 30 per cent or so in the previous year. And in Asia and emerging markets, the devastation was even more pronounced, with declines of 50 per cent or more being common. It was a brave man, therefore, who was prepared to put his hand in his pocket and start investing in 2009.

And yet, that was the right strategy to adopt. In the 12-month period beginning in January of 2009 the US equity market, as measured by the S&P500 index, rose 25.6 per cent. The equivalent index in the UK, the FTSE100, rose 30.1 per cent, and on a global basis, equities rose by 30 per cent, according to the MSCI World index. Emerging-market equities outperformed all other asset classes, recording 78.5 per cent growth in 2009. And this was merely an average, which means that some countries enjoyed even higher growth rates in their equity markets, notably Russia.

I am sure many of you are wondering if this performance will be repeated during the next 365 days. The answer is almost certainly "no". You can argue this on the basis of market fundamentals, analysing the things that economists like to look at: GDP growth, budget deficit, employment rate, inflation, and interest rates, to name but a few. Or you can merely look at the past and ask "how often does the best-performing asset class in one year follow up with the best performance in the next". The answer is, not very often. In fact, according to Blackrock (formerly Merrill Lynch), the answer is never - at least not in the last 20 years.

The best-performing asset class in 2009 was emerging-market equities. Blackrock quotes a growth rate of 74.5 per cent for that year, which is slightly different from the MSCI figure (likely attributable to different "emerging market" in a different but it's close enough for my purposes. But in the previous year, 2008, emerging-market equities turned in the worst performance among all sectors: negative 53.2 per cent. Anyone who mastered percentage growth rates while doing his high school maths will realise instantly that these two annual growth rates, over a two-year period, will combine to leave him some way short of his original capital investment. (Prizes are available for anyone who can tell me by how much.)

As equities were racing away during 2009, the usual safe havens of government bonds and other investment-grade bonds, at the other end of the scale, turned in the worst performance of any asset type, with a miserly 6.9 per cent. And yet, in the previous year, they enjoyed the best performance of any asset class with an even more miserly rate of 5.2 per cent. It's a case of the first being last and the last being first.

Blackrock's analysis superbly illustrates how volatile individual asset classes can be from one year to the next, though in the long term average growth rates can be quite acceptable. According to the form's analysis, £10,000 invested 25 years ago in the FTSE100 index would have grown to £118,000 by the end of 2009, which is equal to a yearly growth of 10.4 per cent. Provided you can wait for a quarter of a century, that is a very fine return. But are there any other ways of achieving reasonable growth in a shorter period of time?

If you had been clever enough to have selected the best-performing asset class for each of the last 19 years and rolled your winnings over from one year to the next, an initial investment of $1,000 would have grown to $436,000. By my calculations, this is equivalent to an annual growth rate of 38 per cent. If, on the other hand, you had used the strategy of betting on the asset class that had performed best in the previous year, your $1,000 would have grown to a measly $1830, equivalent to only 3 per cent annual growth over 19 years. It's an amazing difference, and illustrates well how much you stand to lose if you base your investment strategy on short-term past performance.

What I am trying to say is that investing in one type of asset only can be dangerous unless you are prepared to hold it for a very long time. In addition, attempting to guess the future by looking at immediate past performance can seriously erode your wealth. So what to do? The answer is diversification. Construct a portfolio that takes advantage of the performance characteristics of the different asset classes, with maximum profit your goal. Again, betting on last year's hot class is almost always a mistake.

RMB Asset Management is advising its clients looking for growth to craft a portfolio with the following asset ratio: equities at 49 per cent, bonds or fixed income at 28 per cent, 12 per cent in commercial property, 8 per cent in hedge funds or alternative strategies and cash holdings of 3 per cent, the exact mix of assets in the firm's Harmony Portfolio US Dollar Growth Fund, which returned 23 per cent last year. While this figure is a little less than the S&P 500's 26 per cent record in the same period, the fund was much less volatile, resulting in fewer sleepless nights for investors.

Bill Davey is a financial adviser at Mondial-Financial Partners Dubai. Write him at bill.davey@mondialdubai.com