Wine Specialty Funds in Portfolio Diversification

Mutual Funds as an Investment Vehicle

In the complex world of investments, there are many vehicles in which one can invest. Mutual funds are an excellent way for investors to gain market exposure without spending a large amount of time in portfolio research and management. As mutual funds have gained in popularity and become the principal investment vehicle for countless investors, the mutual fund market has flourished. As new funds constantly enter the marketplace, we see a wide diversity of strategies and holdings—from funds devoted entirely to gold and gold-related industries to global funds that seek ultimate diversification. A fund trend that has gained some following internationally but has yet to appear in strength on U.S. shores is the wine fund. Wine funds are more like REITs than traditional mutual funds, in that they hold physical, non-commoditized assets.

The combined assets of the nation's mutual funds increased by $237.1 billion, or 2.1 percent, to $11.209 trillion in March 2010, according to the Investment Company Institute's official survey of the mutual fund industry. Clearly, the mutual fund industry is a booming business, but what draws investors to mutual funds? The key to the success of mutual funds lies in their inherent diversity. For investors seeking diversification, the mutual fund is the easiest vehicle to maximize diversification while maintaining constant surveillance of the underlying securities. For an individual investor to manage a widely diversified portfolio would require countless hours, as well as knowledge and skill that the majority of individual investors simply do not possess. By utilizing the economic principle of comparative advantage, we see that it is infinitely more efficient to outsource the management of investments in order to maximize the amount of investable income. Thus, we see the advent of the mutual fund. People from all backgrounds become able to invest competently with minimal outlay of time, in return for a fee charged by the fund manager who spends all of their time managing those investments.

Mutual funds come in all shapes, sizes, and varieties. The breadth of the market enables investors to select investments suitable to their individual risk level and investment objectives. The scope of mutual funds covers all sectors of the economy. One can invest in funds that only purchase technology sector securities, or in a fund that only invests in manufacturing company securities. Other funds invest based on investor risk tolerances—funds are often categorized as aggressive, moderately aggressive, moderate, or conservative. Still others are segmented by market capitalization, focusing on securities within different market cap sectors such as small cap, mid cap, and large cap. It is this diversity that emphasizes the need for non-traditional funds. By being able to diversify away from the securities markets, one is able to hedge against market volatility and the inherent instability of all investors being in the same market.

A beta is a measure of risk that, when applied to investment portfolios, provides useful statistical information. It indicates a fund's past price volatility relative to a particular stock market index. Most mainstream equity funds have betas in the range of 0.85 to 1.05 (fairly close to the 1.00 beta represented by the market in the aggregate). Especially conservative stock funds may register betas as low as 0.75, meaning that in a minus 10 percent market decline, their values might be expected to fall 7.5 percent. Aggressive funds with betas of 1.25 might see their values fall by 12.5 percent. The same general dimension of relative volatility also prevails in rising markets.

Traditional mutual funds can flourish in both bull and bear markets. Arguably, the more specialized the fund, the more subject it is to market fluctuation in the particular specialty. The catch-22 of this situation is that without a certain amount of risk—which means being specialized to some degree—there is no way to beat the collective index. Complete diversification results in sub-standard returns. As we see in Table 1, the more specialized the fund, such as the global equity fund, the higher the return. The correlation between specialization and returns indicates that diversification is the destroyer of fortunes rather than the builder of them. However, as we know from practice, an undiversified portfolio is not only irresponsible but also reckless.

This inherent requirement for specialization creates the need for non-traditional investments. In order to create a balanced portfolio with diverse offerings, investors are being drawn to all kinds of new investment opportunities.