Portfolio Diversification

The objectives of diversification are to:

• Reduce the variability of the fund's total return;
• Reduce the exposure to any single component of the capital market;
• Reduce the risk of returns not tracking or exceeding inflation;
• Increase the longer-term risk-adjusted return potential of the fund.

To achieve diversification, the fund will invest in the various categories of assets classes viz., equity shares, debentures, government securities, etc. In most countries, portfolio diversification is subject to the regulations of the local government.

Selecting the Asset Classes

In any investment management system, once the objectives of the investment are set-up, the investor has to focus on the asset classes to invest. The resulting assets of a pension fund must be invested in such a way that the "value creation" goals for the business are most likely met. Capital market investment is one of the key investment vehicles for the pension funds around the world, though they have very unpredictable movements. This study includes current levels of stock and bond indices, their historical changes, inflation projections and also studies of the real estate values. Hence, the capital market expectations play a crucial role in setting the choice of asset classes.