Diversification (Finance) and its benefits

Diversification is the most important technique available to investors. It helps you avoid losing all of your money in financial crisis. Diversification is allocating your investing capital to different asset classes with the goal to reduce your total risk. 

 

But question arises as to why to invest in variety of assets when some may perform poorly.  Why not invest only in assets with greater returns.  The simple answer is that investment returns depend on variety of future events, which nobody can reliably predict.

Diversification can help reduce the risk associated with these future events.

Making diversification effective can take more than simply spreading out your money in more than one asset. The real benefits of your diversification strategy can be fully achieved by owning uncorrelated multiple asset classes which behave differently under different economic conditions.

For example, having a portfolio of 30 oil and gas stocks isn’t diversification. Even owning stocks and bonds may not be sufficiently diversified. Investing in variety of unrelated industries is real diversification.   

Different assets are exposed to different types of risks. If one asset perform badly there are good chances that other assets would perform well and would nullify the impact of bad-performing asset.

Investors should distribute their investments in assets with varying degree of liquidity, risk, and potential of earning. If you are investing in financial markets, you may diversify by investing in real assets like gold or real estate. Financial markets also offer avenues for diversification. Bond market often moves in opposing direction to that of equity. Investing in bonds can save you during period of falling share prices.

Although no amount of diversification can save you from complete disaster but it provides your assets with considerable protection against random events.

   

How Sugar industry can help ease Pakistan's energy crisis

Taking too much sugar may be bad for your health, but not for your country. Sugar industry can help ease the energy crisis faced by Pakistan for more than a decade.

The energy shortage is growing with ever increasing population and rising domestic consumption.  The production gap can be met by mobilizing sugar mills to produce electricity. The bagasse produced by sugar mills can be used to produce thermal energy for onsite use as well as production of electricity.

In many countries of the world sugar mills are earning more from selling electricity than they earn from selling sugar. Sugar industry is second largest, with 89 mills; agro based industry of Pakistan after textile and therefore offers tremendous potential to fill the energy gap.

A sugar mill crushing 2000 tons cane can produce 9 MW of electricity after meeting its own requirement. The total estimated power potential of Pakistan’s sugar industry is 2000MW. The cost of producing electricity is very low as the fuel (bagasse) is available at no cost. The raw material need not to be transported so considerable savings can be made on transportation head. Transportation losses can also be reduced as bagasse power plants are decentralized. Moreover, there is zero carbon dioxide emission as bagasse is a biomass. During combustion biomass re-releases carbon dioxide into the air.

Most of the sugar mills in Pakistan use bagasse to heat inefficient boilers of 26bar. The Indian sugar industry is using 50bar boilers, which uses half as much bagasse as used by 26bar boiler to produce the same megawatts of energy.

The high pressure boiler (80-100bar) available in Pakistan cost from 700 million rupees to 1 billion rupees. The high investment involves make it unfeasible for using these boilers only for 120 days, the cane crushing season. For the rest part of the year sugar industry wants to utilize coal and other biomass fuels like rice bran, corn cobs.

Problem of public debt and its solution

Nawaz Sharif’s Govt. over his four year tenure added 35 billion $ to Pakistan’s debt pile. The maximum number of loans – amounting to $10.1 billion, the highest taken out in any single year during the country’s history – was obtained during the last year of Nawaz’s government.

Starting from July 2013, with every passing year, the external debt pile kept growing due to the government’s inability to implement policies that could have ensured sufficient non-debt creating inflows.

PML(N) Government earlier diluted Fiscal Responsibility And Debt Limitation Act 2005. PPP Govt. was not different either. The external debt, from 2007 to 2012, grew by 20billion $. The lack of necessary oversight led successive Governments to be irresponsible regarding receiving loans and the loan terms. It seems that Governments have no incentive to be concerned about the repayments of these loans. According to World Bank, average grace period, since 2007, of new external debt commitment is 6.6 years. Pakistan has political cycle of 5 years; less than average grace period, therefore elected Governments don’t have sufficient incentive to worry about the repayment of these debts.  

Moreover, another unnoticed fact is that democracy is inherently consumption oriented. Political parties have to face pressure from masses to meet their basic needs. This pressure is severe in countries having huge poverty. Political parties in order to woo these poor masses try to spend as much public money as possible. Resultantly Benazir income support programme, sasti roti scheme and other such schemes are initiated.

Such schemes are funded by using tax money or borrowed money but don’t generate any returns. Successive Governments have to borrow in order to pay these loans. Hence, the country is struck in debt trap.

Moreover, Democratic Governments are elected to rule for a limited time period before next elections. Their short term tenure forces them to borrow long-term funds, which are costly as compared to short-term loans. On the investment side these Government spend on projects which have short gestation periods. These short-run projects generate low returns. Resultantly the debt burden began to accumulate and multiply. The precarious position on exchange rate front further aggravate the matter as the weakening of domestic currency increases the external debt stock in domestic currency. 

To pay back Govt. is left with two option either tax masses, which are its voters, or borrow more to return the previous loans. The elected Government go for the second option.

The solution to the above issue is having strong checks and balances on elected Government. Some of the checks and balances are mentioned below.

1.    Central bank’s freedom should be ensured.

2.    Civil Servants should be given constitutional guarantee (regarding job security, tenure security).

3.    Chancellor for public works should be appointed who would check Govt. from initiating useless public works.

4.    The most important step which may need constitutional amendment is election of deputy prime minister, who would be responsible for economics and finance, from senate.

The above mentioned steps though difficult but can be implemented.  A step by step approach can be adopted. Furthermore the date from which such legislation would be implementable should have necessary time lag so, that Government doesn’t become adversary of its own decision.