Friday Highlight  

Diversification helps in times of stress

Diversification helps in times of stress

Multi-asset approaches have increased in popularity amongst investment advisers and advised investors in recent years.

This reflects the impact of regulation, such as MiFID II, as well as the intuitive attraction of the ability to invest across asset classes to deliver investment outcomes.

For instance, figures produced by the IA show the amount managed on a multi-asset basis almost tripled between the end of 2009 and the end of 2018, from £77.3bn to £208.8bn. 

One of the key reasons for this growth has been the built-in diversification offered by multi-asset strategies.

By their nature, they allow fund managers to invest across company shares and a variety of fixed income instruments worldwide, and often offer the freedom to consider other asset classes, such as real estate, commodities or infrastructure.

This diversification is seen as offering peace of mind to advisers and investors, as savings are not ‘all in the one basket’ in a period of market stress. 

As well as the increased security offered by a diversified portfolio, being able to access potential investment growth across a range of asset classes is an attractive feature for many.

Often, advised clients need to invest for growth – to afford a large expense in the future, build up savings during a working lifetime, or ensure the long-term sustainability of a retirement pot – but are only too aware of the potential impact of a large loss in value of an investment, especially if this occurs over a short period.

In particular, investors can be much less tolerant of losses when the value of savings are high and have been built up over many years.

Pound-cost ravaging

Equally, one of the results of the pensions freedoms has been a much higher level of awareness of ‘pound cost ravaging’.

This occurs if the need to withdraw a regular income from an investment pot to meet living expenses in later life is affected by large losses in the value of that pot, making it difficult or impossible to make up the returns. 

Diversification offers a key ‘first line of defence’ to investors looking to manage the risk of an investment portfolio.

Taking on different types of risk – such as equity risk, credit risk or inflation risk – is likely to be rewarded to different extents at different times, and so offers a smoother ride to the long-term investor who remains concerned about the consequences of shorter-term market gyrations on the value of their investments. 

Having exposure to a range of asset classes would have been a blessing in many of the periods of market stress seen in the past two decades, when equities and bonds in particular have tended to move in different directions.

However, in periods of markedly negative investor sentiment and elevated market volatility, even diversification can have its limits.