A STUDY ON THE POWER OF DIVERSIFICATION: HOW FUND

DIVERSIFICATION HELPS BUSINESS OWNERS

CHAPTER I

INTRODUCTION

Background of the Study

In financial markets, it is common to not put all of the eggs – which mean assets – in one

basket – which means fund – because there is a need for selection on which basket to put which

eggs in and how many eggs to put in each basket. However, significant issues and problems have

encountered, specifically as it is connected to the value of fund diversification to the people.

Diversification of funds is important in minimizing the probability of introducing risk in terms of

having one type of investment vehicle only.

Despite of the importance of fund diversification in the economy, even in developed

economic countries with full-grown financial markets, the financial literacy is low. Broadly, only

around 33% or 1-in-3 adults of the world's population are financial literate or have knowledge

about the basic concepts behind everyday financial decisions. Moreover, among the four points

(risk diversification, inflation, numeracy, and compounding interest) which are subject to the

definition of financial literacy, the most recognized are numeracy (the system of computing

interest) and inflation. Additionally, Risk Diversification is the least recognized as point which is

subject to the definition of financial literacy (Lusardi 2019). On the other hand, it is only 25% of

Filipino adults are well informed about basic financial view in the Philippines, And sadly, the

Philippines ranked at the bottom 30 over 144 countries surveyed on financial literacy (Klapper et

al., 2015). This only means that the financial literacy in the Philippines should have to be

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prioritized on. The second problem is that when crises, pandemics, political instability and other

unfortunate events occur – specially on a global scale, investor sentiment is often heightened by

the uncertainty caused by these events. This is because events tend to adversely affect national

economic performance and financial and commodity markets. As a result, market uncertainty is

followed by emotional or sentimental behavior that cannot be accurately predicted, thus creating

fear that causes investors to take further risks (Economou et al., 2018). Of the many previously

reported crises (ranging from finance to health to politics), the current COVID-19 pandemic

appears to have had the greatest impact on global financial and commodity markets. On March

23, 2020, the U.S. benchmark stock market index S&P 500 lost as much as 35% of its value

relative to its recent historical maximum achieved on February 19, 2020. Fear of an infectious

disease and anxiety may cause investors to sell stocks, leading to price volatility (Wang Q., et al,

2020). Furthermore, in the Philippines, due to the outbreak of the COVID-19 pandemic, the 58%

of Filipino adults’ financial behavior today is different than it was in pre-pandemic times

(Bangko Sentral ng Pilipinas, 2015). Preference for risky assets is higher than pre-COVID-19

risk-free assets. Stocks are the most preferred investment option. The impact of COVID-19 has

changed investment preferences. A risk-free investment is recommended. Insurance is the most

preferred investment option, followed by gold, bank deposits and public provident fund (PPF)

(Himanshu et al, 2021).  Third in China, higher minimum wage evaluation has reduced the

likelihood of firms investing in human capital and the level of human capital investment per

worker (Haepp et al, 2016). Similar to investment, in the Philippines, many Filipinos are willing

to invest. However, more than half (63%) said they didn't have the money to do so (Bangko

Sentral ng Pilipinas, 2015). Aside from the financial literacy and fear of investment the lack of

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earnings also affects the perspective of investors in investment vehicles as they use to prioritize

their basic needs instead of investing their assets.

As the fund diversification is the mean of allocating the risk in different types of funds or

investment vehicles, significant issues and problems have encountered. Financial illiteracy may

lead to wrong and poor financial decision making, while the fear of investing – in the part of

potential investors increased the financial market uncertainty which has made investors more

sensitive to investment losses than to investment gains which adversely affects investment

decisions. The lack of earnings may result to not having any interest about financial market,

investment vehicles, and investing.

Although the literature regarding fund diversification is expanding, studies related about

the value of fund diversification are limited. It is important to understand the value and

limitations of fund diversification and the circumstances in which it applies. Extensive research

has been done on this concept for decades, but more research is needed for investors to better

understand the potential impact of diversification on their portfolios. Therefore, there is a need

for this study in order to provide results which are needed that will help investors in their

financial decision making mostly in economic downturns.

CHALLENGES OF FUND DIVERSIFICATION

Diversification is an investment approach that helps the business or individual to generate

more predictable results while reducing the risk in portfolio. Individual strongest line of defence

against one investment failing or one asset type performing poorly is diversification. If the

investments are diversified, while some lose value, others could gain and offset the loss. 

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 The following are the challenges of fund diversification that experienced by Filipino

citizens:

1. Managing Complexity 

2. Balancing Growth and Focus

3. Developing a diversification plan

4. Over-diversification 

5. Working with a small amount 

Managing complexity The seemingly unlimited supply of freely accessible investing

knowledge and the enormous universe of readily available investment opportunities are two

factors contributing to the complexity that abounds. The need to include other perspectives in the

investment selection process is another factor that adds complexity. Family, friends, and

members of the board are all possible sources of fresh ideas. This can result in investments being

made in the future for less than ideal reasons. Owning less liquid investments like private equity

funds leads to a certain amount of complexity that cannot be avoided. These have extended

lifespan, uncontrollable exits, and managers who may oversee many active funds. Such

circumstances may call for several fund investments in order to preserve access to funds and

diversification across vintages. 

Balancing growth and focus Balanced funds are a somewhat risk-averse investment

strategy, but even so, bonds will vary if interest rates move, making them not completely risk-

free. Bond values will decrease when interest rates rise since bonds and interest rates have an

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inverse relationship. Budgetary balance, according to proponents, safeguards social programs

like Social Security as well as future generations.

Developing o Diversification plan Business owner’s most noteworthy assets are many

times their most prominent shortcomings too. The assurance, readiness to face challenges and

steady quest for an objective might be positive qualities for building a business, yet not really fit

to sound venture arranging. The way of life will also be important. Owners who have put in a lot

of hard work over a long period of time to establish a sustainable business may want to start

enjoying some of their wealth. As a result, the focus will shift from wealth creation to wealth

preservation, which may necessitate a new approach to financial planning.

Over-diversification, Examining levels of volatility is the generally accepted method for

assessing risk. That is, the riskier an asset is, the more rapidly it moves over time within a

portfolio or stock. Volatility is measured using a statistical idea called standard deviation. Thus,

for this article, you can consider standard deviation signifying "risk". Despite the fact that this

could not be further from the truth, many investors have the erroneous belief that the reduction in

risk associated with each additional stock in a portfolio is proportional. There is evidence to

suggest that diversification is ineffective beyond a certain point in terms of risk reduction.

Working with small amount Funds may be selected by the investor if they have a

moderate risk appetite. Diversifying portfolio doesn't require more than four to six different

strategies. Therefore they are not required to invest in more than one or two schemes if the

investment is small. Having a small amount of funds limits someone capability to diversify their

funds.

2009 PROVINCIAL INVESTMENT INCENTIVES ORDINANCE OF BATAAN in

accordance to Chapter I: Title and Declaration of Policy Section 2. Declaration of Policy states

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that It is the policy of the Provincial Government of Bataan to attract, promote and welcome

productive investments from foreign and local investors, partnership, corporation, and

governments, in activities which significantly contribute to provincial industrialization and

socio-economic development to the extent that foreign investment is allowed in such activity, by

the Constitution and relevant laws.  Foreign as well as local investments shall be encouraged in

enterprises that significantly expand livelihood and employment opportunities for Bataeños;

enhance economic value of farm products; promote the interest and welfare of the consumers;

expand the scope, quality and volume of exports and their access to foreign markets; and/or

transfer relevant technologies in agriculture, industry and support services.

ADVANTAGES OF FUND DIVERSIFICATION

Risk Management A portfolio's investments are mixed together in a wide variety as part

of the risk management approach known as diversification. To reduce exposure to any one asset

or risk, a diversified portfolio combines a variety of different asset classes and investment

vehicles. This strategy is justified by the idea that a portfolio made up of various asset classes

will, on average, produce superior long-term returns and reduce the risk of any given holding or

security.

Diversification strives to increase long-term profits while also reducing overall risks. This

is because different time periods have varied effects on how each asset responds. Several

investment classes, including equity, fixed income, real estate, gold, and other commodities, are

represented in a diversified portfolio. These elements contribute to the portfolio's ability to

provide above-average long-term returns.

The act of spreading your investments across and within various asset classes is known as

diversification. And rebalancing entails making consistent corrections to guarantee that you

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continue to meet your goal allocation over time. All of these are crucial strategies for controlling

investment risk. The key to these tactics is variation. If properly implemented, asset allocation,

diversification, and rebalancing should produce a balanced mix of lifetime performance and risk

protection. (Troy Segal, 2022)

Crucial Element Achieving Long – Term Financial Goals The main consideration for

many investors when choosing their portfolios is often producing competitive returns. Yet

limiting potential losses is just as crucial, and managing risk tends to take on greater importance

during periods of severe market decline.

It usually takes a diverse investment strategy to maintain a long-term investing strategy

through times of choppy market conditions. To reduce market volatility, diversification includes

distributing your investing funds among various asset classes. You might be more likely to keep

a long-term portfolio position by "smoothing out" market performance, which could increase

your chances of achieving important investing objectives.

By diversifying their assets, an investor may be able to manage risk and reduce the

volatility of an asset's price movements. Despite the fact that your portfolio may be well-

diversified, risk cannot always be completely eliminated. Given today's erratic weather, volatile

market, and brief economic cycles, it is imperative to diversify the holdings in your portfolio.

Most importantly, receiving professional advice is suggested while building a portfolio. How to

methodically diversify the portfolio, take long-term earnings into account, and lower risks in

both the short and long terms are all things that a financial expert may advise. (Eccles&Krzus,

2010).

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 Reduce Unsystematic Risks In order for the beneficial performance of some assets to

offset the bad performance of others, diversification aims to smooth out unsystematic risk

occurrences in a portfolio. The benefits of diversification only apply if the assets in the portfolio

are not fully correlated; in other words, if they react to market factors differently, frequently in

opposite directions.

Throughout the development of banking theory, the essential purpose of banking has not

altered. The primary function of banking is still the management of risk, assets, and liabilities.

The volatility of liquidity risk can be used to identify the early warning signs of a banking crisis.

Determining how internal and external factors affect the liquidity risk of Islamic and

conventional banks was the goal of this study. Time series regression analysis of Islamic banks

and conventional banks is used in this work. According to the survey, Islamic banks keep greater

liquidity than traditional banks.

In general, diversification aims to reduce unsystematic risk. These are the risks specific to

an investment that are unique to that holding. Examples of diversifiable, non-systematic risks

include: Business risk the risk related to a specific company based on the nature of its company

and what it does in the market. Financial risk the risks related to a specific company or

organization's financial health, liquidity, and long-term solvency. Operational risk the risk related

to breakdowns in the processes of manufacturing or distributing goods. Regulatory risk the risk

that legislation may adversely impact the asset. Through diversification, investors strive to

reduce the risks above which are controllable based on the investments held.

(WaeibrorheemWaemustafa, SurianiSukri, 2016).

Diversifying Across Asset Classes Alternative assets are an emerging asset class that

extends beyond investing in stocks and bonds, according to more recent theories on portfolio

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construction. Investors can now easily invest in real estate, cryptocurrencies, commodities,

precious metals, and other assets thanks to the advancement of digital technology. Once more,

there are distinct levers for each of these classes that determine what makes them effective.

Five major financial markets—equities, bonds, currencies, commodities, and real estate

—appears to be weakly or at most moderately integrated, according to our results from using

principal component analysis (PCA). This is despite an upward trend in market integration. We

find that adding new asset classes, such as oil, precious metals, currency, and real estate to a

traditional portfolio of stocks and bonds significantly improves its risk-adjusted performance

using mean-variance portfolio simulations and out-of-sample analysis to assess the advantages of

diversification. The benefit of diversification is minimal during contagion periods, which are

those times when the correlation of the PC regression residuals is significantly different from

zero. Yet, a further benefit from Compared to other times, diversification is higher during

contagion periods. Stocks perform best during normal times, whereas bonds offer the best hedge

during contagion periods. (Mohamed Arouri, DucKhuong Nguyen, KuntaraPukthuanthong,

2014)

DISADVANTAGES OF FUND DIVERSIFICATION

A large proportion of business innovation occurs in smaller firms that are narrowly

focused on a few technological or business goals. If these companies diversify too widely, they

risk losing focus, increasing bureaucratic inertia, and reducing their ability to respond to market

changes quickly and creatively. When leading innovative companies begin to lag, a domino

effect occurs along the cutting edge of technological innovation, resulting in slower economic

growth and even less innovation. See, (Chron Contributor, 2021)

The following are disadvantages of diversified businesses:

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 1. Overextension of Resources

2. Lack of Expertise

3. Insufficient Capital Resources

4. Reduction in Innovation

Overextension of Resources Overextension of a company’s resources is one limitation

of diversification. Every division of a corporation, no matter how large, requires sufficient

resources to maintain its infrastructure and operations, or it will begin to decline. If a company’s

directors seek to expand in too many directions at once due to mismanagement, excessive

ambition, or simple greed, both old and new sectors of the company may suffer from a lack of

attention and insufficient resources. Run both conservative and optimistic sales forecasts to help

the estimation of the resource requirements.

Lack of Expertise One limitation of diversification is overextension of a company’s

resources. Every division of a corporation, regardless of size, requires adequate resources to

maintain its infrastructure and operations, or it will begin to decline. If a company’s directors

attempt to expand in too many directions at once due to mismanagement, overachievement, or

plain greed, both old and new sectors of the company may suffer from a lack of attention and

insufficient resources. To help the estimation of the resource requirements, create both

conservative and optimistic sales forecasts

Insufficient Capital Resources Businesses that diversify into areas that necessitate

additional infrastructure, employee training, and travel between widely separated areas risk

increasing their costs to the point where the venture’s value is jeopardized. Even the most

profitable diversification entails additional costs and overhead. Businesses must carefully

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examine the numbers before venturing into new territory to ensure that they do not spend more

than they stand to make. The safest areas for a company to diversify into are those that are

closely related to what it already does, so there is pre-existing expertise and infrastructure.

Reduction in Innovation In this day and age of corporate takeovers, it’s not uncommon

to see a company expand into a field that has nothing to do with its original operations. If a car

company buys out a food distribution company, for example, it must retain the original

company’s expertise or risk getting into trouble. Different companies’ operations necessitate

entirely different skill sets. If, as in the preceding example, food company executives are fired or

voluntarily leave, the new owners may find themselves with an asset they don’t know how to

manage. If the portfolio is managed by someone else, probably don’t pay as much attention to it,

or you wait until it’s too late.

CHAPTER III

CASE EVALUATION

1. A. Why something is working

Definitely, given the areas of consideration, there are individuals who claimed to practice

and associate themselves with proper and viable financial management. Practically, this

is interlinked with their profession and job background which are all inclined to business,

finance, and corporation. As such, based on the survey, majority of the respondents who

agreed with the potential of financial management and fund diversification are those

individuals who are business managers, owners of businesses, or financial experts.

Besides, with the advent of a much stringent awareness and information drives regarding

financial literacy and management nowadays, it became evident that younger generation

are much exposed to the concept and ideologies of financial management. Thus, with the

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 demography of the respondent, it is evident that younger populace are much eager with

the utilization and mechanization of fund diversification.

2. B. Why something is not working

Financial management among Filipinos is a deliberately unfounded and often neglected

due to various reasoning. As such, there is a complete necessity for Filipinos to acquire

financial literacy. As defined, in formal literature and popular media, the terms financial

literacy, financial knowledge, and financial education are frequently used

interchangeably. Financial literacy is defined differently by different sources, but they all

have one thing in common: they all center on money, knowledge, and use. Financial

literacy involves components like knowledge of financial instruments (e.g.,

understanding the distinction between a stock and a bond or a fixed-rate

mortgage);understanding of financial principles (such as inflation, compounding,

diversification, and credit scores);possessing the numeracy or mathematical abilities

required for making informed financial decisions; and taking part in certain activities,

including financial planning. Certainly, in the Filipino socio-cultural aspects, the

widespread belief among Filipinos is that after receiving a salary, spending takes

precedence over saving. What remains is saved. Nothing can be saved if there are none

left. Therefore, only 16 percent of Filipinos, according to a study by Philam Life, are

prepared to cover medical expenses in the event that they are diagnosed with a serious

disease, despite the fact that 96% of them are concerned about their own and their

family's health. Likewise, due to a lack of financial education, the number of senior

dependents—retirees who rely on their children for financial support—is on the rise.

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 Therefore, with the given insights, it is evident that some are not into fund diversification

because of their job condition, demography, knowledge, and alike.

3. C. Hypotheses

The researchers hypothesized that the Bataan residents, particularly the minimum wage

earners, are not knowledgeable enough of the concepts and aspects of financial

management thus, resulting to being financially illiterate. Further, the researchers also

deemed that the residents underwent few undertakings of the said matter either by poor

foundation of financial literacy during their schooling, lack of financial education

employed in the curriculum, or basically has no idea about the mentioned topic. Besides,

the researchers also hypothesize that the respondents have a few experiences with fund

diversification mainly because they are still new with the business world. Apart from it,

the socio-cultural influence among the respondents had contributed to the difficulty of

feasibly using fund diversification as a means of strengthening their financial meets in

life.

CHAPTER IV

PROPOSED SOLUTION

1. A. Answer to the Questions

In order to resolve crises in financial illiteracy of Filipinos, there is an abrupt necessity

for the government to empower the economic sector through widening information drives

and such related programs and activities. Further, providing materials and relevant

instruments among companies to equip their employees about the beneficial impacts of

fund diversification should be mechanized to maximize the potential of a much

financially capable corporation and individuals. More so, the financial sector such as

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 banks and stock markets should categorically opened a sector for minimum wage earners

to invest their savings. Likewise, in order to motivate the minimum wage earners to

invest, the government should hike up the salary rate to correspond with the continuous

increase in the prices of goods and services. At the same time, decreasing the tax

inclusions should be implemented to augment the possibility of a much capacitate

individuals. In addition, incorporating financial literacy and management as well as fund

diversification in the curriculum of Senior High School students as well as programs in

colleges with no relation or addendum of business courses should be implemented to

strengthen the future of the Philippine financial market.When, it comes to the Bataan

residents, having a recommending letter for the awareness drive of business entities in the

area should be subjected to the local government like mayors and barangay captains to

significantly increase the financial literacy of the relative population. Moreover, the local

government should capitalize the availability of school-grounds and government facilities

to magnify the amount of awareness and consciousness of residents regarding the

advantage of being financially literate.

2. B. Methodology

In order for the proposed answer to be feasible and to put up in action, the study should

be shown and be discussed to local authorities to make them sentient and apprehensive

regarding the issue. After that, a concept or operational plan should be drafted for the

employment of Information, Education, and Communication (IEC) materials or

symposium to future adopted communities. It should include a brief summary regarding

the project and an objective that guides the project to its main goal. Further, it should

include the details of the project such as the speakers, theme, individuals involved, and

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everything in between. After that, a letter should be drafted and should be sent to the

local office or municipality for approval of the project. Consequently, the project can be

implemented.

CHAPTER V

FINAL STATEMENT

In financial markets, it is common to not put all of the eggs – which mean assets –

in one basket – which means fund – because there is a need for selection on which basket

to put which eggs in and how many eggs to put in each basket. However, significant

issues and problems have encountered, specifically as it is connected to the value of fund

diversification to the people. Diversification of funds is important in minimizing the

probability of introducing risk in terms of having one type of investment vehicle only.

Despite of the importance of fund diversification in the economy, even in developed

economic countries with full-grown financial markets, the financial literacy is low.

Definitely, given the areas of consideration, there are individuals who claimed to

practice and associate themselves with proper and viable financial management. As such,

based on the survey, majority of the respondents who agreed with the potential of

financial management and fund diversification are those individuals who are business

managers, owners of businesses, or financial experts. The researchers hypothesized that

the Bataan residents, particularly the minimum wage earners, are not knowledgeable

enough of the concepts and aspects of financial management thus, resulting to being

financially illiterate.

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 CHAPTER VI

RECOMENDATION

A financially literate person is more likely to have complete control over their finances.

Engaging in the fundamentals of accounting can prepare you for a variety of challenges that you

will inevitably face on your journey. When it comes to fund diversification, the following factors

must be considered:

1. Asset Allocation: Diversify your investments across different asset classes, such as

stocks, bonds, real estate, and commodities. By spreading your investments across

various asset classes, you can reduce the risk associated with a single investment type.

2. Geographic Diversification: Invest in a mix of local and international markets to

spread your risk. Diversifying across different countries and regions helps reduce the

impact of localized economic or political events on your portfolio.

3. Investment Vehicles: Consider investing in different types of investment vehicles,

such as mutual funds, exchange-traded funds (ETFs), or individual stocks and bonds.

Each investment vehicle has its own risk profile and potential returns, so diversifying

across these options can help manage risk.

4. Sector Diversification: Allocate your investments across various sectors or industries,

such as technology, healthcare, finance, and energy. This diversification can help protect

your portfolio from downturns in any specific sector.

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5. Risk Tolerance and Investment Goals: Assess your risk tolerance and investment

goals before diversifying your funds. If you have a higher risk tolerance, you may be

comfortable with more aggressive investments. Conversely, if you have a lower risk

tolerance, you may opt for a more conservative approach.

6. Regular Review: Regularly review and rebalance your portfolio to ensure it aligns

with your investment objectives. Market conditions and your financial goals may change

over time, so adjusting your diversification strategy accordingly is essential.

7. Education: Seminars re-educate people on what is more efficient and effective in

terms of fund diversification.

Remember, it is always advisable to consult with a qualified financial advisor who can

take into account your specific circumstances, risk profile, and investment objectives

when providing recommendations on fund diversification.

CHAPTER VII

IMPLEMENTATION

1. Define Investment Goals and Risk Tolerance: Clearly establish your investment

objectives, whether it's long-term growth, income generation, or capital preservation.

Determine your risk tolerance level, considering factors such as your financial situation,

time horizon, and comfort with potential market fluctuations.

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2. Research and Select Investment Vehicles: Conduct thorough research on different

investment vehicles available in Bataan, such as mutual funds, ETFs, stocks, bonds, and

real estate investment trusts (REITs). Evaluate their historical performance, fees, and risk

characteristics. Consider consulting with a financial advisor who can provide insights

based on your specific requirements.

3. Determine Asset Allocation: Based on your risk tolerance and investment goals,

decide on an appropriate asset allocation strategy. This involves determining the

percentage of your portfolio allocated to each asset class, such as stocks, bonds, real

estate, and commodities. Consider your time horizon and diversify across different asset

classes to reduce risk.

4. Select Investments within Each Asset Class: Identify specific investments within

each asset class that align with your diversification strategy. For example, if investing in

stocks, choose companies from different sectors and regions. If investing in bonds,

consider a mix of government bonds, corporate bonds, and municipal bonds.

5. Monitor Geographic Diversification: Assess the geographic diversification of your

investments. Allocate funds to both local and international markets to reduce the impact

of regional economic events. Consider investing in global or international funds to gain

exposure to foreign markets.

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6. Regular Portfolio Review and Rebalancing: Monitor the performance of your

portfolio on a regular basis. Review the allocation percentages of your investments and

rebalance if necessary. Rebalancing involves selling or buying assets to bring the

portfolio back to its target allocation. This helps maintain the desired diversification

levels.

7. Stay Informed and Educated: Stay updated with market trends, economic news, and

regulatory changes that may impact your investments. Continuously educate yourself

about investment strategies, asset classes, and market dynamics. This knowledge will

empower you to make informed decisions about your portfolio.

Remember, this implementation plan is a general guideline, and it's essential to tailor it to

your specific financial circumstances and seek advice from a qualified financial advisor

who can provide personalized recommendations based on your needs.

CHAPTER VIII
REFERENCES

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