When planning an investment portfolio, one of the most critical decisions is how to allocate assets between growth and defensive investments. The right balance between these two asset classes determines your portfolio’s risk, return potential, and ability to withstand market fluctuations.

In this blog post, we’ll explore growth and defensive assets, their roles in portfolio construction, and how investors can optimize allocations based on individual needs and financial goals.

Understanding Asset Classes for Retail Investors

In previous posts, we examined:

• The different financial markets and investment options available to individual investors.
• Systemic risk factors such as equity risk, term risk, and credit risk, which offer an additional return premium.
• Other risks that increase uncertainty but do not provide higher returns.

This risk-based approach allows investors to strategically select asset classes that align with their risk tolerance and return expectations. To simplify investment choices, we categorize assets into two broad groups:

Growth Assets

These investments carry higher risk but offer greater potential returns over the long term. They include:

• Equities (Stocks) – Publicly traded companies across developed and emerging markets.
• Listed Real Estate (REITs) – Real estate investment trusts that provide exposure to property markets.
• Private Equity & Venture Capital (less common for retail investors).

Defensive Assets

These assets aim to provide stability and capital preservation. They include:

• Government Bonds – Issued by national governments and considered low-risk.
• Investment-Grade Corporate Bonds – Issued by financially strong companies.
• Cash & Cash Equivalents – Low-risk investments such as savings accounts and short-term Treasury bills.

The allocation between these two groups is the single most important factor in determining an investor’s overall portfolio performance and risk exposure.

Allocating Growth Assets

Global Diversification

Growth assets, particularly equities, should be publicly listed on recognized stock exchanges, ensuring price transparency and liquidity. A well-diversified equity portfolio should include investments across:

• 23 developed markets
• 24 emerging markets

A common approach to diversification is to allocate growth assets based on global market capitalization. This ensures exposure to companies of various sizes, industries, and regions, creating a resilient portfolio.

Home Country Bias

Investors often favour stocks from their home country due to familiarity and perceived stability. For a New Zealand investor:

• The NZ market accounts for only 0.1% of the global market.
• Investing solely based on market size would result in minimal exposure to local companies.
• However, New Zealand stocks provide imputation tax credits, allowing residents to offset corporate taxes against personal tax obligations.

Many KiwiSaver funds allocate around 25% of growth assets to New Zealand and Australian shares. A reasonable home country bias for individual investors ranges between 5% and 15%, balancing local exposure with global diversification.

Currency Considerations

New Zealand investors spend in NZD, so holding NZ-based investments can reduce currency risk. However, over-concentrating in one economy can expose portfolios to country-specific risks such as:

• Natural disasters (e.g., earthquakes affecting real estate and agriculture).
• Commodity price fluctuations impacting exports.

A globally diversified equity allocation, with a moderate home country bias, provides an optimal balance of return potential and risk management.

Allocating Defensive Assets

Purpose of Defensive Assets

Defensive assets counterbalance the volatility of growth assets. While they may offer lower returns, they provide stability and income generation. The primary defensive investments are government and investment-grade corporate bonds.

Selecting the Right Bonds

For defensive assets to effectively reduce portfolio risk, investors should:

• Prioritize Short and Medium-Term Bonds – Reduces sensitivity to interest rate changes (term risk).
• Choose High-Quality Issuers – Investment-grade bonds (BBB+ or higher) have lower default risk.

Avoiding Risk in Defensive Assets

It may be tempting to chase higher returns by investing in lower-quality bonds or extending bond duration. However, this can cause bonds to behave more like equities during market downturns, reducing their defensive benefits. Instead, maintaining a disciplined allocation to high-quality, shorter-duration bonds ensures true portfolio protection.

Currency Hedging for International Bonds

New Zealand investors often include international bonds in their defensive allocation. To avoid excessive currency risk, it is advisable to invest in hedged international bonds, which neutralize exchange rate fluctuations and preserve the bond’s stability.

Finding the Right Balance Between Growth and Defensive Assets

The growth-to-defensive ratio is the most significant decision an investor will make. Key considerations include:

• Risk Tolerance – Higher risk tolerance may justify a larger allocation to growth assets.
• Investment Time Horizon – Longer time horizons allow for greater equity exposure.
• Income Needs – Defensive assets provide steady income, suitable for retirees or conservative investors.

A well-balanced portfolio might look like:

• Growth Investors (80% Growth / 20% Defensive) – Suitable for long-term investors comfortable with volatility.
• Moderate Investors (60% Growth / 40% Defensive) – Balanced risk and return, suitable for most investors.
• Conservative Investors (40% Growth / 60% Defensive) – Prioritizes stability and income, suitable for retirees.

Conclusion

Determining the right mix of growth and defensive assets is the foundation of successful portfolio construction. By:

• Diversifying globally and managing home country bias.
• Selecting high-quality bonds to maintain portfolio stability.
• Aligning investments with risk tolerance and goals, investors can build robust portfolios that withstand market fluctuations while achieving long-term financial success.

Next Steps

In the final post of this series, we will explore how to implement a personalized investment strategy, incorporating preferences such as Environmental, Social, and Governance (ESG) investing.

For more insights into investment and financial planning for migrants in New Zealand, check out our YouTube channel Pacific Wealth (NZ) or the other articles on our website.