We have already seen in our article about diversification that a prudent investor does not put “all his eggs into one basket” and that an investment fund allows an investor to adequately diversify his investments to spread the associated risks.
But be careful: “Risk Diversification” does not mean “elimination of investment risks”. Never forget that by entrusting your savings to an investment fund, you do not invest in an abstract structure, but in a vehicle that in turn invests your savings in accordance with its investment policy. In other words, when buying an investment fund, you are investing ultimately in the assets in which the fund invests. By buying an investment fund that invests in German equities, you are simply buying German equities through the investment fund.
Whatever the investment fund of your choice, you will face market risk. If the prices on the market your fund has invested in are falling, even the best fund manager can hardly escape this trend, all the more so because the manager is obliged to stick to the investment policy the fund has committed to follow. Thus, a fund whose investment policy is to invest in German equities – and that investors bought for the very reason that they wanted to invest in German equities – cannot decide overnight to sell its German shares simply because the market is falling and start investing in French securities instead.
The degree of investment diversification – and reduction of associated risks – offered by an investment fund will also depend on the fund’s investment policy. Thus, a mutual fund that invests in a limited number of companies in a specific sector, such as biotechnology for example, offers a significantly lower degree of diversification than a fund that allocates its investments to a very high number of securities of companies from many different economic sectors.
The more diverse the fund’s equity portfolio, the greater the chance that a declining price of one security is compensated by a rising price of another one. (On the other hand, the probability that the rising price of a security is offset by the declining price of another one is real too. The more diverse a portfolio, the more limited is the chance for spectacular gains.)
UCITS funds are required by law to ensure adequate diversification of their investments.
