Diversification as an investment belief: not putting all your eggs in one financial basket

15 July 2022

Diversification as an investment belief: not putting all your eggs in one financial basket

The saying goes don’t put all your eggs in one basket. In some way, we believe it is important that your investments aren’t concentrated in one area but are instead spread over a range of assets across the investment universe.

This is why diversification is one of our core investment beliefs.

Most investors will be aware that investing in a range of assets across industries and geographies is considered a sensible idea.

This can help reduce negative impact from changing market conditions, without necessarily hurting long term returns.

A recent example of this has been the widely fluctuating cost of fuel and other commodities. This has drive up the value of oil and gas companies, which lagged behind in 2020 and the first half of 2021. This is in direct comparison with several companies which had been performing well who have now begun to struggle. A diverse range of investments will have had a smoother performance over this period compared to those concentrated in one sector.

A free lunch in finance

While diversifying stock selection can offer some mitigation against risks, there will still be systemic or market-wide risks that could have negative implications. These include inflation, rising interest rates, or political instability - all three of which we are seeing in 2022.

This is why we also look to diversify across all asset classes, as bonds, equities, property, and alternative investments will react differently to the same market conditions. Asset allocation is another of our core Investment Beliefs, and by spreading investments across different asset classes, we can mitigate against a variety of risks.

According to Joanna Stocks, Head of Liquid Alternatives: “Whether it’s asset allocation or stock selection, this is supposed to improve the outcome for investors. I should be able to construct a portfolio that aims to provide similar levels of return for lower levels of risk.”

Therefore, diversification is sometimes known as the only free lunch in finance, she adds.

While it is important to acknowledge that diversifying cannot eliminate risk, by combining asset classes that don’t move in perfect sync with each other, diversification should lead to reduced volatility and smoother returns.

Putting the belief into practice

We typically look to diversify your money at three levels: stock selection, the mix of fund managers and how we combine these funds into Portfolios.

Fund manager selection is absolutely key in ensuring diversification, and a lot of time and effort goes into making sure we only work with managers who have a demonstrable edge in this regard.

While some fund managers will be constrained in what or where they can invest (for example in a regional equity strategy), we would still expect them to be looking to diversify. According to Dr Sarah Ruggins, Head of Multi Asset Research: “these fund managers will still diversify across investment style sectors and industry factors to just name a few things they may be looking at. So, throughout their processes, they will aim to reduce stock specific risk in their strategy by ensuring that there are various drivers of risk and return at play.”

We also look at how different fund managers work together in multi manager fund. A recent example of this was in 2021, when we merged our Alternative Assets, UK Absolute Return and Multi Asset funds into our new Global Absolute Return fund. Part of the logic for the merger was that none of the original funds were diversified enough in their own right.

In creating this new fund, we removed some fund managers, rebalanced others, and added new fund managers. For the fund managers we removed, or whose holding was reduced, it was not necessarily just related to performance. Rebalancing was also done to ensure the fund was sufficiently diversified.

Ruggins added: “The result is a product with improved diversification across managers and strategies. In time, this has the potential to smooth out volatility and delivers more consistent performance in a simplified structure. By ensuring clients remain fully diversified at every level, we believe this will help reduce risk and volatility, without sacrificing long term returns.

The value of an investment with St. James’s Place will be directly linked to the performance of funds you select, and the value can therefore go down as well as up. You may get back less than you invested.

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