Diversification—a Tried-and-True Investment Strategy

As we reflect on the market events of 2008 and the market rallies of 2009, it is an appropriate time to consider the importance of investment diversification. This time-tested investment strategy involves spreading your account balance(s) among different types of investments, such as U.S. and international stocks, bonds and inflation-protection securities. The funds administered by the General Board of Pension and Health Benefits (General Board) offer a variety of diversified investment opportunities. While diversification will not necessarily protect a portfolio over short periods of time, it is a tried-and-true, long-term, disciplined investment strategy.

You probably have heard that “past performance is not a predictor of future results”—and this is an important message to remember. No one, not even the most skilled financial expert, can predict the direction a stock, a bond or an entire market will take. For example, opinions currently vary widely among experts on the outlook for inflation, deflation and economic recovery. Following a strategy of diversification offers the best chance of protecting invested principal in any economic environment over long periods. The General Board’s funds are broadly diversified in a number of ways, including by:

• types of investments,
• subsectors of investment classes (e.g., stocks in a variety of different industries),
• sizes of companies,
• investment styles,
• geographic locations, and
• the external investment management firms.

In addition, the General Board has carefully constructed its funds to complement one another. For example, the Stable Value Fund (SVF) focuses on high-quality corporate bonds and positive social purpose loans, which generate income. The Inflation Protection Fund (IPF) invests in groups of inflation-protection U.S. government securities, inflation-linked bonds from foreign countries and commodities. The SVF and IPF complement the Domestic Bond Fund (DBF), which invests in traditional fixed-income assets, higher-yielding bonds and securities in companies drawing earnings and growth from foreign countries.

The Domestic Stock Fund (DSF) includes equities that are diversified between stocks in growth companies, which are believed to have positive earning potential, and value companies, whose stocks appear attractively priced compared with market metrics. Additionally, the DSF’s equity portfolios are further diversified between large, medium and small companies.

The General Board also uses a combination of large corporate asset managers, which have tremendous research and analytical capabilities, and smaller “boutique” asset managers, which may bring innovative approaches to investing. Each asset manager has its own strategy and style. The General Board also uses passive investing to replicate the performance of certain stock indices, such as the S&P 500. Passive investments are designed to closely track—not beat—a market. Investors in the DSF also gain exposure to private equity and private real estate investments, opportunities not generally available to individual investors.

Conversely, the International Stock Fund (ISF) focuses on similar equity strategies in foreign stock markets. Investments are made in industrialized nations and developing countries. International exposure has been a key diversification strategy in 2009, as markets outside the U.S. have experienced relatively strong returns. Another advantage of the ISF is that its investments are made in companies from many countries and diversify exposure to securities that are denominated strictly in U.S. dollars.

Another key aspect of the General Board’s investing philosophy is its commitment to socially responsible investing. This strategy, while seeking both financial and social returns, also further enhances our investment diversification. The General Board’s socially responsible investments include commercial real estate loans that support affordable housing, community facilities and charter schools. Our socially responsible loans have fared well in this economic climate, due to the need for affordable housing and the tax incentives that generally accompany these properties. The General Board’s positive social purpose loans also complement the private real estate portfolio, which comprises equity investments in more traditional commercial real estate sectors.

While no one investment approach can protect your retirement savings from the uncertainties of the market, diversifying your portfolio is a time-tested, prudent approach. By diversifying your investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too many potential earnings.