Diversification—investing across various asset classes, regions, sectors, and strategies—forms the foundation of multi-asset investing. It helps mitigate risk and can enhance your chances of achieving higher returns. While different asset classes may rise and fall in popularity, the principle of diversification remains timeless. Let’s delve into this essential aspect of portfolio construction.
What is Portfolio Diversification?
In simple terms, diversification means spreading your investments across multiple assets to limit exposure to any single one. If an individual investment suffers losses, the overall impact on your portfolio is minimized. Conversely, strong performance from standout investments can contribute positively to your overall returns without dominating them.
Nobel Prize winner Harry Markowitz famously referred to diversification as the “only free lunch” in investing, highlighting its ability to reduce risk without sacrificing returns. Although it may not be entirely ‘free,’ consider the principle similar to a buffet—you’re less likely to be stuck with one unappealing dish if your plate includes a variety of options.
Why is Diversification a Good Strategy?
Investing heavily in a single sector or asset class can be highly risky. For instance, if you had invested entirely in the travel and leisure sector during the COVID-19 lockdowns, you could have faced substantial losses.
Many investors are tempted by the allure of high-performing sectors. An example of this is the tech boom of the late 1990s, where rampant speculation around internet companies drove valuations to unsustainable levels, culminating in the dotcom bust of 2000.
A Strategy for Managing Losses
A more prudent approach is to distribute your investments across various sectors such as financials, energy, consumer goods, healthcare, and utilities. Additionally, consider diversifying internationally, investing in markets from the UK and US to Europe, Japan, and emerging economies. It’s also wise to include different asset types—such as equities and both government and corporate bonds—as we do at Nutmeg.
A solid multi-asset strategy can yield significant benefits. A wealth manager like Nutmeg can allocate your investments across these various markets, adjusting the proportions based on changing market conditions.
Diversification and Portfolio Risk
A well-diversified multi-asset portfolio typically consists of growth-oriented assets, like equities, paired with income-generating investments, such as bonds. Each category carries different risks; generally, equities are viewed as higher-risk assets with the potential for greater returns and losses compared to lower-risk, yielding assets like government bonds.
However, as witnessed recently with the disappointing performance of bonds, there are no guarantees that assets will consistently behave according to risk expectations in the short to medium term.
In risk-managed portfolios, such as those offered by Nutmeg, we regularly adjust the allocation across asset categories to align with client preferences. Historically, equities have had a low correlation with bonds, traditionally seen as safe-haven assets, meaning that poor performance in one could be offset by gains in the other.
Are ETFs Well Diversified?
At Nutmeg, we invest in exchange-traded funds (ETFs) rather than directly in stocks. ETFs are designed to passively track an index or market and provide a cost-effective way to achieve diversification by pooling investments across numerous underlying assets. For example, an ETF that tracks the S&P 500 gives you a slice of all 500 companies in the index.
ETFs are ideal diversification tools for today’s wealth managers. Nutmeg has access to a universe of over 1,800 ETF strategies, with the average Fully Managed portfolio containing over 8,000 underlying securities spread across global equities, bonds, and commodity markets.
How Nutmeg Can Assist You
Diversified portfolios come in various forms, from fixed allocation strategies that maintain specific asset weightings to fully managed portfolios where investment managers take a hands-on approach daily. In both scenarios, diversification is vital to achieving client investment goals while adhering to varying risk levels. Professional investment managers also access insights and funds that may not be available to individual investors.
While investment trends may rise and fall, the principle of diversification remains constant. Ensure you leverage this strategy to fully realize its benefits.
Risk Warning
As with all investments, your capital is at risk. The value of your Nutmeg portfolio can fluctuate, and you may end up with less than you invested. Past performance and forecasts are not reliable indicators of future results.
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