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BMO Financial Group

November 24, 2011 10:47 ET

BMO Economics Report: Case for Investment Diversification Still Strong

TORONTO, ONTARIO--(Marketwire - Nov. 24, 2011) - The case for investment diversification across a multitude of sectors, asset classes and geographies has actually been strengthened by events of recent years, despite the multitude of problems facing the rest of the world's economies, the sustained outperformance of domestic markets in the past decade and the historic rise in the Canadian dollar, according to a new report from BMO Economics.

"Despite the appearance of financial markets moving more or less in lock-step, there are still marked performance divergences across and within asset classes," said Douglas Porter, Deputy Chief Economist, BMO Capital Markets. "Despite palpable frustration among investors due to this year's equity market weakness and despite many markets performing similarly, there is still a very compelling case for investment diversification."

"This report reinforces what we have been telling our clients for many years," said Serge Pepin, Head of Investments, BMO Investments Inc. "It's critical for investors to ensure their portfolios are well diversified in order to protect themselves against market volatility."

Mr. Pepin also reminded investors to stay informed and not jump to hasty conclusions. "Hurried decisions most often do more harm than good."

The report notes the importance of diversification from three investment perspectives:

By sector, size and style: Not only does sector diversification prevent overexposure to a particular area of the market at times of extreme fundamental shifts (i.e., the dot-com bust), but it also helps to smooth returns over the economic cycle. The case for size and style diversification is somewhat less compelling, but an investor can tick all of these boxes by holding a diverse basket of equities spread across multiple sectors.

By asset class: While it sometimes seems that markets have been moving in almost precise unity in recent years, the benefit of diversification across asset classes has arguably increased. For example, Treasuries have been a go-to safe haven at times when equity markets are under pressure, with the correlation of monthly returns between the S&P 500 and 10-year Treasuries deeply negative over the past year. Meantime, gold prices have shown little persistent correlation with equities, which is actually a good thing-no correlation means that returns are not related, as opposed to a negative correlation which acts an outright hedge. Finally, commodities and stocks remain highly correlated in this environment, moving together as risk appetites and economic growth expectations ebb and flow.

By country: Amid the hydra-headed European debt crisis, the deteriorating U.S. fiscal landscape, Japan's multi-decade funk, and fears over a hard landing in China, it's understandable that Canadian investors would prefer to stay close to home. However, market events of this year in fact present a solid counterpoint. Even with Canada's relative safe-haven status, the TSX has trailed far behind U.S. equities this year, and lagged even Britain and some other key markets. And, taking a longer view, given Toronto's relatively strong showing of the past decade, there is now at least some risk of a prolonged period of relative underperformance in the years ahead.

The complete report can be downloaded at bmocm.com/economics.

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