The Finatical

Week of October 12th, 2021 - Diversification, Natural Gas Prices in Europe, China's Electricity Shortage

Finatic

Aditya Bagga

, and

Sidh Aneja

Oct 12, 2021

What is Diversification?

Investing and trading are desirable terms when it comes to achieving complete financial freedom but it is also well known that there is an element of risk involved while engaging in these activities. Diversification is a simple strategy of reducing that risk by diversifying your investor portfolio in different asset classes. The diversification does not necessarily have to be across different asset classes but can also be within classes. You can also buy two different types of stocks or any other asset with low correlation. The stocks should be such so that when a circumstance arises it won’t affect both the stocks in the same manner. This is done in an attempt to predict that the positive effects of one stock will outweigh the negative effects of another.

Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks yields the most cost-effective level of risk reduction. The investing in more securities generates further diversification benefits, albeit at a drastically smaller rate.

Types of Asset Classes

Stocks—shares or equity in a publicly traded company

Bonds—government and corporate fixed-income debt instruments

Real estate—land, buildings, natural resources, agriculture, livestock, and water and mineral deposits

Exchange-traded funds (ETFs)—a marketable basket of securities that follow an index, commodity, or sector

Commodities—basic goods necessary for the production of other products or services

Cash and short-term cash-equivalents (CCE)—Treasury bills, certificate of deposit (CD), money market vehicles, and other short-term, low-risk investments

Foreign Diversification

Foreign diversification can give added bonuses to investors if they invest in foreign securities with low correlation with domestic securities. The odds that a market upset will affect two different nations in the same manner are very low. Foreign diversification is a risk management strategy that gives the investor some protection from domestic losses by offering foreign profits.

Pros and Cons

Pros

Reduces portfolio risk
Hedges against market volatility
Offers higher returns long-term

Cons

Limits gains short-term
Time-consuming to manage
Incurs more transaction fees, commissions

FinaticTrends - 2 Financial Trends

1 - Sharp Rise in Natural Gas Prices in Europe

Natural gas prices in Europe and the United Kingdom have quadrupled over the past six months to record highs. Gas accounts for 40% of UK electricity generation, almost a quarter in the EU and is also a key fuel for heating (80% of UK homes) and industrial production. The surge in gas prices has fed through to wholesale electricity prices, which have almost tripled since March. High gas prices make gas-intensive industrial activity unprofitable. UK fertilizer plants have shut down as gas prices spiked. This has hit the supply of CO2, a by-product of fertilizer production, and a major input to many processes, including food and beverage production and nuclear power plant cooling. Governments have scrambled to respond. France and Italy have announced direct subsidies to consumer energy bills, while Spain imposed a windfall tax on energy companies that have benefitted from the price surge. The UK government is considering support for surviving energy suppliers to take on customers of failed suppliers, given that existing fixed tariffs do not cover the cost of supplying new customers. Last week the UK government agreed a deal with CF Fertilizers to restart CO2 production at its plant on Teesside.

2 - China Faces an Electricity Shortage

Amidst other significant concerns (the Evergrande crisis, COVID-19, high debt, troubling demographics, etc.), China is now facing a shortage of electricity that is threatening economic recovery. In the past month, 16 of 31 provinces in industrial regions have implemented electricity rationing. Administration said that this was done in order “to avoid the collapse of the entire grid.” In some cities, the shortage of electricity has led to the failure of traffic lights, causing significant traffic congestion. In Jilin Province, authorities say that electricity and water shortages could last at least until March 2022. In Guangdong Province, authorities have urged people not to use elevators for the first three stories of office buildings. Some companies have had to switch factory operations to overnight due to daytime shortages. In many provinces, factories have temporarily shut down or are operating below capacity. In some cities, streetlights are not turned on at night. Power to homes and small businesses is cut during the day and resumed at night. For those living in tall buildings, the lack of elevator service means staying inside. This situation stems from the requirement that electricity be rationed in order to avoid a complete shutdown of the electric grid. The situation stems from a shortage of coal that is used to generate electricity. It will be interesting to see how a power outage will impact the global economy.

Financial Guidance

“A man who pays his bills on time is soon forgotten.” - Oscar Wilde

Wilde explains that if you pay your bills on time, you will essentially be “forgotten” by your creditors, which is great thing because, if they’re remembering you, that probably means you owe them money.

Money Fact

North Korea is the largest counterfeiter.

North Korea has mastered the art of counterfeiting U.S. currency and in 2009, an estimated $45 million worth of these fake bills have been identified.