Anthony Chan of BlackRock explains how advisers can guide retail clients appropriately when adding emerging market ETFs to their portfolios.

Date: Mar 2011

Tags: Emerging markets, Bias, Suitability, Asset allocation, Portfolio construction, Diversification

• When it comes to retail investors in Asia, there is a strong preference for stock-picking and home bias
• Investors and advisers should view diversification in enabling them to go for more upside opportunities and to participate in more markets without necessarily increasing their level of risk
• Investors should also realise that diversification doesn’t replace a good hedging strategy in terms of minimising downside risk
• For many retail investors, it is possible that there is a lower allocation to emerging markets than could be justified

When it comes to retail investors in Asia, especially in Hong Kong and Singapore, there is a strong preference for stock-picking, said Anthony Chan in an interview.

Yet the challenge comes from the fact that it is impossible for any investor to cover stocks in the entire investment universe, he explained. So individuals tend to only stock-pick in their domestic markets based on companies they know well.

However, said Chan, diversification and a sound investment strategy are key to achieving investment goals – so a core asset allocation is essential.

Biases to be aware of

According to Chan, many people in Asia tend to have a lot of home bias in their portfolio, given that they are picking stocks in their home markets.

Another thing for retail buyers to understand is that they shouldn’t simply focus on returns. Instead, they need to realise they can play macro themes more effectively with an asset allocation approach, which can also be less research intensive.

Over-concentration and returns

While returns are always going to be maximised by selecting the one security which does the best over a particular period, the ability of an individual to do this is very difficult, said Chan.

Investors and advisers should therefore view diversification in enabling them to go for more upside opportunities and to participate in more markets without necessarily increasing their level of risk.

At the same time, Chan said investors should also realise that diversification doesn’t replace a good hedging strategy in terms of minimising downside risk.

So if people are 100% exposed to equities, then regardless of the amount of diversification across the asset class, a fall in equity markets generally will have a negative impact on the portfolio, he explained.

Emerging markets within portfolios

Where emerging markets fit within investment portfolios relates to the objectives and risk appetite an investor has, said Chan.

However, for many retail investors, it is possible that there is a lower allocation to emerging markets than could be justified.

Part of the reason, said Chan, is that people leave out these opportunities if they deem themselves to be conservative.

At the moment, however, he said emerging markets are roughly 15% of overall market capitalisation. As a result, if a portfolio allocation is less than this, then an investor is underweight this sector and should be aware of this.

Investors and advisers also need to consider that by increasing emerging market exposure from 10% to 20% of an overall portfolio, for example, this doesn’t increase the risk as much as many people think, due to the diversification effect, added Chan.