Diversification is the key to reducing risk in a portfolio. Holding stocks across business sectors allows the superior performance of stocks in “hot” sectors to counter balance poorer performance in stocks not doing as well.
Sounds good enough but some studies indicate it takes a portfolio of 25-30 stocks to achieve a maximum level of risk reduction.  Others claim one can get by with fewer than 25 to 30 but the task of researching, selecting, and then monitoring portfolio performance is simply too arduous a task for many retail investors.
There are three ways investors with neither the time nor the temperament for self-directed investing can diversify their investments:
1. Managed Funds2. Exchange Traded Funds (ETF)3. Listed Investment Companies (LIC)
The primary differences between managed and exchange traded funds are where you buy them and fees charged. Managed funds are typically offered by financial service providers or directly through fund companies.  Exchange traded funds can be bought and sold on the open stock market with lower fees.  Both passive and active products are offered in most markets, with passive funds tracking an index while active funds have professional managers buying and selling for the portfolio with a goal of outperforming the market. Here in Australia there are currently less than ten actively managed ETFs, known as ETMFs (Exchange Traded Managed Funds.)
Listed Investment companies are similar to ETF’s with a key difference beneficial to investors.  Exchange Traded Funds are structured as trust vehicles while LIC’s are structured as companies.  In effect, when you buy into an ETF or ETMF you are buying units in the trust as opposed to buying stocks in an LIC.  Therefore, while both trade openly on the ASX, LIC’s are subject to the reporting and governance requirements of corporate structured entities.  For the investor, this means more transparency and less effort following the stock due to the disclosure requirements mandated by the ASX.
There is another difference that make LIC’s a more attractive option for some investors.  Trusts are open-ended, meaning should a horde of new investors come calling the ETF simply sells them the additional units.  LIC’s are closed, meaning that same horde will drive up the price of the stock due to the fixed supply.  What this means is there are times when an LIC may be trading at a premium or discount to its net asset value (NAT – which is the total value of all portfolio assets the entity holds, minus liabilities, divided by shares outstanding.)  As the following 16 March graph from Bloomberg shows, the price of an ETF tends to stay very close to its NAV, which is not the case with an LIC.

The implication here should be obvious – there are times when the stock of an LIC is available at a bargain price for long term investors.
Despite their differences, the three vehicles for instant diversification share the same core underlying philosophy.  If you have searched the business descriptions of various ETF’s or LIC’s, you should recognize the following statement:
• …invests in a range of sectors, such as energy, materials, industrials, consumer staples, banks, property trusts, telecommunications, healthcare, information technology and utilities … in order to maximize long-term returns to shareholders through a balance of capital and dividend growth.
Investing in such a wide array of business sectors may minimize risk but common sense and simple math suggests it also can maximise mediocrity.  The hope of any actively managed investment vehicle is that the managers can pick enough winners to offset the losers or mediocre performers to come out with a positive overall return.
Over time the strategies employed by these providers have evolved and now many have narrowed their investment targets.  There are ETF’s and LIC’s that focus exclusively on specific countries or entire geographical regions; others that focus on high growth companies; others restricted to large caps or small caps; and still others focused on a broad business sector, like energy.
There are two recent LIC entries on the ASX that exemplify the shift to a more refined and narrow investing focus.  One is Blue Star Alternative Investments (BLA).  This company’s unique approach to diversification is to invest in a variety of assets other than traditional stocks.  While investing strictly in private endeavors sounds strange, the results this company has produced since it began trading on the ASX are far superior to the tried and true approach of the majority of ETF’s and LIC’s.   Blue Sky listed on the ASX on 24 January of 2012, closing its first trading day at $0.95.   The BLA share price as of the close on 1 December of 2016 was $7.25, an increase of 663%.
Australian Foundation Investment Company (AFI) has been in business since 1927 and focuses on a broadly diversified portfolio of Australian blue chip stocks.  The following price movement chart compares AFI with newcomer BLA.

AFI’s ten year annualised rate of return is 5.59%.  The best performing LIC on the ASX over the last decade is Carlton Investments (CIN), specialising in “established, well managed Australian listed entities that are anticipated to provide attractive levels of sustainable income and also long term capital growth and in companies that enable a high portion of income to be received as fully franked dividends.”  Carlton’s 10 year return is 9.17%.  Here is how Carlton compares to BLA over the last five years.

While Blue Sky has yet to withstand the test of time, its rate of return since its beginnings is 16.7%.  The group certainly is off to a good start, especially for a business that does not buy ASX listed stocks for capital growth and rising dividends.  So what do they buy?
Blue Sky is a holding company for four fund management groups, each focusing on a different alternative asset.
1. Blue Sky Private Equity (BSPE) Pty Limited operates as a private equity and venture capital firm, investing in a wide range of businesses based on growth potential, regardless of sector.
2. Blue Sky Private Real Estate Pty Limited (BSPRE) develops and manages both residential and commercial real estate.  Earlier in the year BSPRE announced a joint venture with Goldman Sachs in the purchase of a student accommodations provider – The PAD – with plans to add to PAD’s facilities for student housing in Australia and New Zealand.  Construction began in Melbourne and Adelaide in mid-November with the company announcing its entry into the US market through a joint venture with Atlanta based Student Quarters.
3. Blue Sky Investment Science Asset Management Pty Ltd (BSISAM) is a global hedge fund that takes both long and short positions in equities, fixed income, currencies, and commodities.
4.  Blue Sky Water Partners Pty Limited (BSWP) focuses on real assets in water, including investing and managing water entitlements, water and agricultural infrastructure, and expansion capital for Agribusiness.
5. Blue Sky Alternative Access Fund listed on the ASX in June of this year under the CODE BAF, focusing strictly on alternative investments.

The Blue Sky Alternatives Access Fund Limited (‘The Alternatives Fund’) is a listed investment company mandated to invest in a diversified portfolio of alternative assets managed by a wholly owned subsidiary of Blue Sky Alternative Investments Limited (‘Blue Sky’). BAF is now the parent company of BLA.

BLA reported a 57% profit increase for FY 2016 and has a 54.8% two year earnings growth forecast along with a projected increase in dividends over two years of 41.4%. On the company website Blue Sky has an intriguing graph to support its strategic approach.

Another interesting recent LIC IPO to consider is Bailador Technology Investments (BTI). The company debuted on the ASX on 17 November of 2014 with a first trading day closing price of $0.96.  Since then the stock price has risen a modest 12.5% to its current level of $1.08.
Bailador may be an example to support the belief that investors are wary of LIC’s that invest strictly in non-listed equites.  That is what Bailador does but they focus on promising areas within the technology sector – software, Internet, mobile, data, online market places and telecommunications-related businesses…
Bailador does not take positions in start-up companies, focusing instead on companies with exemplary management that are already generating revenues between two and ten million dollars.  Bailador has only been in business since 2010 and is interesting enough to attract the attention of ASX investment group Washington H. Soul Pattinson and Co. Ltd (SOL) that currently has a 20% stake in Bailador.
Here are the nine companies in Bailador’s portfolio:
• DocsCorp – a hybrid desktop/cloud provider of four document management products serving 3,500 customers and 250,000 end users.  The company has 32% annual revenue growth with 80% of that coming from outside Australia.
• Click Loans Group – a financial technology company offering online home loans and mortgages.
• Rezdy – provides online booking software for professionals in the travel and tourism industry.  The company operates as a software as a service business and has 1,600 customers.  The software platform has generated $1.2 billion in bookings, with 50% of that coming from outside Australia.
• Stackla – another software as a service (SAAS) provider of aggregated social media marketing services across multiple sites.  The company’s average annual return since its founding in 2012 is 260%.  In FY 2015 more that 60% of company revenue came from outside Australia.
• Straker Translations – provides 24/7 cloud based translation services from 80 source languages to 120 target languages.  The company’s revenue growth for FY 2015 was 45%, with revenues reaching NZ$8.0 million.  In early November Straker management announced its intention to go public.
• iPRO Solutions – offers its customers a live 24/7 web-based data verification portal of vendor, supplier and employee information.”
SiteMinder – provides cloud-based SaaS solutions for hotel management.  The company has more than 18,000 hotel customers in 160 countries around the world.  The company has twice been included in the BRW Fast 100 List of Australia’s fastest growing companies.
• Standard Media Index – has developed an aggregator platform for media agencies to track advertising expenditures.  The company has been successful enough in Australia for its founder to move to New York to crack the media market in the US.
• Viocorp – provides a video platform for publishing and broadcasting media content via the web, IPTV, and mobile devices. Viocorp is expanding into Asia and currently serves both the corporate/government and media sectors here in Australia.
Bailador might not be setting the house afire like Blue Sky, but the stock price is outperforming the venerable AFI.  Here’s the chart.