Have we put all our eggs in one basket?

USEAn increasing number of Ugandans hold shares in at least one listed company on the Uganda Securities Exchange. A survey of the composition of our investments is likely to show that significant proportions have holdings in only one company.

We all want to hold shares in a company whose price is on the increase. We should note that with equity, there would be no guarantee of the future price. Even the biggest and most prestigious companies have suffered fluctuations in their prices.

British Petroleum (BP), which has a massive investment from UK pension funds, plunged to a miserable low as it fought to reduce its oil spills. On April 24, 2010, BP boasted a share price of £63.9. Four months later, the price is £37.5. Who would have predicted this downturn? Only the insiders have such information, leaving the rest of us with no idea of how share prices will move.

Equity investments are known to be volatile as the market determines their price. Buyers and sellers determine their movement. A high demand for Dfcu shares will give sellers the upper hand negotiating their preferred price, leaving buyers to accept the high price.
Many may argue that investment in shares is rewarding. There’s no doubt of its potential to reward, but do we consider the risk of our investment? Imagine an investor with money in only BP who needs to urgently liquidate his shares today; he would make a loss from his investment.

In addition, had the Ugandan market been severely affected by the recent global financial crisis, an investor who had only bought shares in the financial services sector would have suffered huge losses because he had all his eggs in one basket. With at least half the companies on the Uganda Securities Exchange belonging to the financial services sector, a big hit like the financial crisis would leave most of our portfolios on the decline.

If we care about risk, we should diversify. Our investment in equity should be spread across the various companies listed on the Uganda Securities Exchange. There are 13 companies to choose from. That way if a section of the equity investments fall; our other holdings would provide the insurance.

Why don’t we take this investment to another level: Can we spread our risk even further to include both risky and less risky investments?
Corporate Bonds are a good example of a less risky instrument. In Uganda we have Housing Finance, Standard Chartered and EADB bonds to choose from.

Unlike shares, bonds provide a coupon, or what some may prefer to call a fixed interest, at the end of every semi-annual or yearly period. Finally, at the time of maturity, the amount borrowed is returned to the investor.

It is important to note that though bonds offer a guaranteed amount, there’s also the risk of default; namely that the borrower who issued these bonds may not pay back. This risk though should be reduced as the stock exchange tries to ensure safety to bond holders.
There is also the risk of reinvestment of our coupon payments. For those interested in putting their interest into fixed deposits, there’s the risk that the interest rate will fall below today’s interest.

Recent times have proven that this is a likely possibility. The UK Monetary Policy Committee, during the recent financial crisis, reduced its interest rate to the record level of 0.5 per cent, which was the lowest since the Great Depression. In financial investments, there’s a subtle rule that the higher ones risk the greater their expected reward. Therefore expect to take on some risk for good rewards.

My strong advice though is to diversify that risk. Shares are good, but so are corporate bonds. Don’t forget the property market as it can be rewarding. But let us hedge our overall risk by adding fairly risk free assets like Treasury Bills and Fixed Deposits.

The Writer is a senior lecturer at the University of Greenwich, London