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Alternative Market Briefing

Diversification may not be key according to Towers Watson

Tuesday, July 24, 2012

Beverly Chandler, Opalesque London: Robin Penfold and Craig Baker of Towers Watson have arrived at the conclusion that diversification is not necessarily key in equity investors’ portfolios. The pair presents their findings in their paper, Concentrated equity products, why we generally prefer them to diversified products for a typical investor’s portfolio, reporting that adding skilled active management increases expected return without much change in total risk. "We therefore encourage equity investors to seek products with higher expected returns. That means concentrated rather than diversified products" they conclude.

The choice between focussed or diversified investment stems from the investor, the authors write. "Most investors want to improve the return efficiency of their entire portfolio. We call this a 'portfolio-level preference’. That requires them to consider the contribution of asset allocation and active managers. We generally find that using skilled active managers helps to improve overall investment efficiency. That is because expected active returns add to expected asset returns, whilst overall risk barely changes with the introduction of active risk. We therefore expect active management to have positive marginal impact on overall risk-adjusted return."

Penfold and Baker believe that if all other things are equal, investors wit......................

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