The Only Free Lunch in Investing


By Jean Strock, Financial Adviser – 08 October 2021

On 17 August New Zealand registered a community case of the delta strain of Covid 19 and re -entered a Level 4 lockdown. On 5 October Auckland received modest relief with a “lighter” version of Level 3 but the lockdown is still very restrictive with restaurants, hairdressers and gyms still closed. Across the ditch New South Wales, ACT and Victoria are dealing with their own versions of lock down but hopefully seeing the light at the end of the tunnel as vaccination rates rise.

So far the share markets of both countries are holding up well. The NZX50 had been negative since January but rebounded in August as company earnings surprised on the upside, posting a year-to-date return of 1.4%. If this changes and our local markets sell off, we may be glad of our international investments where economies on the whole are opening up.

China is another current focus of investor concern. The recent government crack-down on internet companies and private tutoring has wiped more than US$1 trillion of value from tech stocks such as Alibaba and Tencent since February. Now Evergrande, one of China’s largest property developers faces bankruptcy, potentially leaving bond holders and apartment buyers out of pocket. Evergrande is one of several Chinese property developers in financial difficulties, collectively owing over US$300 billion1. The Chinese government is expected to engineer an orderly restructure of Evergrande to avoid a contagion effect

Then there is inflation and the efforts of central banks to engineer higher interest rates without upsetting markets. There is always something for financial markets to worry about!

In 1952, Harry Markowitz the father of modern portfolio theory described diversification as ‘the only free lunch in investing’

Markowitz’s ‘Efficient Frontier’ is where a portfolio maximises return for a given level of risk/volatility by combining negatively correlated assets. A simplistic example would be combining shares in an umbrella maker with a sun screen manufacturer or in Covid terms combining Tourism Holdings or Air New Zealand with Fisher & Paykel Healthcare.

A clear example of single stock risk on the New Zealand market is A2 Milk. An investor carried away by the performance of A2M since 2017 could now be over exposed to the slump in share price from $21.13 on 3 July 2020 to $6.28 today.

At a sector level income focussed New Zealanders invested heavily in finance company debentures in the period leading up to the Global Financial Crisis of 2007 -2009. Many thought that spreading their money across for example, Hanover, Bridgecorp, and Lombard was being diversified but in fact the common denominator was high risk lending to NZ property developers.

Ultimately 51 finance companies collapsed between May 2006 and December 20122 incurring losses of $3 billion.  The promised higher return by no means compensated for these hidden risks but the disaster at least led to regulatory changes to improve oversight, disclosure and investor protection.

It is not possible to completely remove volatility; the Dow Jones index plunged by 37% during the Covid crash of February/March 2020, but a well- diversified portfolio will provide a smoother, less stressful ride over time.

A portfolio diversified across investment managers, asset classes, geographical areas and currencies is one of the best ways to mitigate investment risk allowing you to stick to your goals and long term plan and enjoy your lunch.



The views expressed in this article are the views of the author. The information provided is of a general nature and is not intended to be personalised financial advice. You may seek appropriate financial advice from a Financial Adviser to suit your individual circumstances.