Partner Content by Royal London

The benefits of diversification

Ken Scott, Head of Investment Solutions at Royal London, explains how our approach to diversification aims to strengthen resilience.

The principal of broad diversification is at the core of our multi-asset portfolios. The performance of each asset class varies with economic environments; and different asset classes will perform better in any given environment. Holding a broad mix of assets offers resilience and gives fund managers tactical opportunities to deliver positive risk-adjusted returns.

Our process

The Governed Range consists of 14 risk-graded, multi-asset portfolios designed to suit your clients’ appetites to risk, whether they’re still saving or accessing their savings, and how long their savings will be invested for.

Each portfolio benefits from a strategic asset allocation (SAA) - a core range of assets designed to deliver above-inflation growth over the medium to long-term. As part of this design process, portfolios are optimised on a set of assumptions, and a series of alternative economic scenarios. This ensures they maximise expected risk-adjusted returns and strengthen resilience to market shocks.

While a portfolio holding just one asset class may deliver superior returns in certain market shocks - e.g. a pure government bond fund during the deflationary Covid shock - it’s unlikely to be the same assets that will fare well in others. While a simple portfolio can produce strong returns in one set of market conditions – as a 60/40 portfolio did while rates reduced in the 2010s – market conditions can turn quickly. So it’s important portfolios are positioned to be resilient to shifts.

Broadly diversified portfolios

Combining a broad mix of assets, helps us improve resilience of the portfolios to various shocks, providing a smoother investment journey. In our drawdown portfolios – the Governed Retirement Income Portfolios (GRIPs) – this is done with a focus on reducing downside risk.

While increased diversification could mean we forgo superior upside in one shock event, we believe the long-term benefit of improved risk reduction outweighs any short-term relative loss. It’s this balance that necessitates an in-depth analysis of each asset class, each portfolio those assets support, and possible future scenario (see table below).

While our multi-asset mix is never the best performing asset class by design, it’s never the worst, aiming instead to provide a smoother investment journey.

This table shows Governed Portfolio (GP) 5, one of our balanced risk portfolios. Higher-risk portfolios have performed strongly in the long-term, but with more ups and downs.

Broad diversification and resilience

We believe the asset allocation within our Governed Range is much broader than our main competitors. For example, we include commodities and commercial property within to provide greater protection from inflation risk – particularly beneficial with the onset of the Ukraine Russia war.

We think carefully about diversification within each asset class. For example, sectoral diversification typically offers more resilience than geographical diversification in equity markets.

Traditional 60/40 balanced funds invest 60% in equities - skewed heavily towards US markets which dominate the global stock-market weightings. These funds performed well over the last decade of low inflation and falling bond yields. However, they’re less likely to offer protection if interest rates continue to rise over the medium term.