In today's uncertain financial times, diversification has become a prudent investment strategy in any portfolio.

Diversification is the process of spreading your money across multiple asset classes to balance your portfolio and minimise the risk of future loss.

As the investment universe continues to expand it is important for investors (both large and small) to expand their options. Traditional diversified portfolios, which blend stocks, bonds and cash, should now include other asset classes such as commodities and hedge funds.

By adding these asset classes you are attempting to further reduce your risk because if any one investment does poorly, it should not break the bank. In other words, you have other investments to help offset any downturns.

Despite the benefits of adding commodities and hedge funds to a portfolio, these asset classes have been virtually non-existent in individuals' accounts because it was difficult to gain exposure to them. Commodity contacts were generally too large for an individual investor to remain diversified while hedge funds were viewed as an asset class only available to the wealthy.

This all has changed over the past few years. Products have been created that track indices covering a wide range of commodities (agricultural products, energy products and metals to name a few). These products are generally offered as mutual funds or ETF's (Exchange Trades Funds), which are traded on large exchanges similar to equities.

At the same time, hedge funds have also become increasingly easier to access. As the industry has ballooned (now roughly $850 billion spread across roughly 7000 funds), minimum investment levels have been reduced as the various fund managers try to compete for new business.

The primary objective of most hedge funds continues to be the reduction of volatility and risk while attempting to preserve capital and deliver positive returns regardless of market conditions.

To reach this goal, fund managers employ various strategies. Fund managers take both long and short positions, use arbitrage, buy and sell distressed securities, trade options, and invest in almost any market event where they forecast potential profit.

Many hedge against downturns in the markets, which is increasingly important due to currency volatility and the potential for a correction in the stock market.

There are different ways to diversify your portfolio

One way is to start by allocating a target percentage of your total investment portfolio to stocks, bonds, hedge funds, commodities and cash. For example, younger, more aggressive investors will tend to invest more heavily in stocks, commodities and hedge funds while older, more conservative investors tend to invest more in bonds, commodities and cash.

To provide assistance, many brokerages and asset management firms publish their recommended allocations.

Once you determine your allocation, it is important to decide how to implement your decisions and which strategies will help you reach your goals.

For example, the aggressive investor may allocate half of their portfolio in growth stocks and equity arbitrage hedge funds.

Conversely, the conservative investor may allocate half of their portfolio in government bonds and money market funds.

Another way is to invest in a Balanced Mutual Fund. Balanced mutual funds offer an easy way to help you diversify. With one investment, you can typically spread your assets among hundreds of companies across multiple asset classes employing various strategies.

The fund managers have the responsibility of making the allocation decision as well as implementing the strategies. These funds will usually provide you with greater diversification at a lower cost than buying individual securities.

At LOM, our investment policy committee currently recommends our Balanced Fund be invested as follows: 49 percent stocks, 30 percent bonds, 12 percent hedge funds, five percent commodities and four percent cash.

There are a number of local companies that offer no-load balanced funds that can be purchased with minimums as low as few thousand dollars. For more information on these funds call your financial advisor or LOM Asset Management at 295-6999.

Successfully diversifying your portfolio implies investing in various investments whose returns are not highly correlated.

The end result should be lower volatility with positive returns. In the end, that is what investing in a balanced portfolio helps to accomplish.

@EDITRULE:

Jon Heckscher (jon.heckscherlom.com) is co-manager of the LOM Balanced Fund.