For David Coombs, fund manager of the Rathbone Multi-Asset Portfolio Funds, it means: “You have to look beyond the traditional high-level asset class splits in portfolios to provide real diversification and manage risk – ie not all fixed income was created equal when it comes to performance during tougher economic times.
“We classify assets by evaluating how liquid we expect them to be and the expected correlation to equities during stressed market environments.”
Mr Coombs cautions: “It’s of little use trying to balance equity risk with credit and high yield, which are likely to be less liquid and correlated to equities during stressed markets.
“Nor, in our view, is it useful to point to property funds as a sensible risk offset to equities, given the pro-cyclical nature of the asset class, and the quite clear issue of liquidity in stressed markets.”
Mr Savry explains diversification means two things to Unigestion.
“Firstly, as we believe that the macro environment drives asset performance over the long-term, it is critical for a strategic allocation to include different assets that each provide their own value-add during different parts of the economic cycle.
“We call this 'diversification across macroeconomic regimes',” he says.
“Secondly, we recognise that expected returns for traditional assets is low and lower than in the past, hence we need to expand the universe of risk premia by including liquid alternative risk premia in order to realise the benefits of diversification. We call this 'diversification across risk premia'.”
Diversification or correlation?
One common mistake is to assume that as long as the assets in a multi-asset fund are delivering positive returns, and heading in an upward trajectory, the fund or portfolio is diversified.
Mr Coombs points out: “If your entire portfolio is heading in the same direction at the same time, even if that direction is higher, this is not diversification, it is correlation, and should lead to investors asking questions about how effectively risk is being managed.”
When it works, a truly diversified fund should be able to protect investors from the worst stock market falls, on the basis that if equities are suffering from a period of poor performance, other assets in the fund will be performing well.
Mr Coombs says this approach to diversification certainly helped his funds during the fourth quarter of 2018, particularly in December.
“Our portfolios all managed to protect against the worst of the falls in equities, with each of them outperforming expected outcomes, given their respective risk budgets,” he recalls.
But it is important advisers and their clients do not simply assume that the more varied the asset classes held in a fund, then the more highly diversified it is.