The IMPORTANCE OF DIVERSIFICATION

The IMPORTANCE OF DIVERSIFICATION

Over the last few years North American equities have had significant growth.  The average fund within the Investment Association North America sector delivering over 100% return: This may cause investors to become over reliant on just this sector, or perhaps disregard their normal portfolio balance and invest more heavily in North American equities. Without some form of rebalance mechanism this over weighting will happen automatically as North American equity values grow. 

This ‘strategy’ may have been rewarding in the short-term but will have significantly increased the portfolio’s risk.

No single country or asset class outperforms all others all the time. Diversification across asset classes and geographies helps to protect investors from specific asset class or country falls. 

Below is the return from the same IA sector over the five years from January 2008.  This time the five-year return is only just over 20%.

It is impossible to accurately predict the returns from every asset class each year. The table below shows the returns from the average fund in 15 different Investment Association sectors.

There is very little pattern to the returns. Though as you might expect cash is often near the bottom of the pile (except in years of crises such as 2008 and 2018 when it is near the top).  And that’s the point – a well-diversified portfolio with a mix of assets from around the world will help mitigate the risk of one or more markets falling in the short-term.

The chart also shows the return from an “Equally “Weighted” portfolio. That is a portfolio that is a simple blend of all 12 of the asset classes.  It is interesting to note how it is never in the top three for returns, but also never in the bottom four.

Of course, investors with a higher risk appetite might wish to move more in equities overall, and more cautious investors into bonds and cash.  A conversation with a professionally qualified independent financial adviser will help investors evolve the best mix of assets to meet their needs – but is always likely to contain a well-diversified mix.

David Norman
January 2021

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