For an investor, a typical diversified portfolio is often seen as simply equities and bonds. This is because, historically, if equity markets underperform, then the relative safety of bonds – owning government debt – could offset this with an increase in value.
This was seen in early 2022. When equity markets dropped following Russia’s invasion of Ukraine, bonds rallied. However, it’s no secret that, overall, 2022 was a tough year for both bonds and equities.
It’s important therefore to understand everything that prudent investment diversification takes into account. It’s not just about the different asset classes of bonds and equities, but also how those asset classes are broken down across variables such as regions and industrial sectors. By including different stock indices from different regions and sectors around the world in a diversified portfolio, you could reduce your exposure to any concentrated risks while taking advantage of areas that may perform well.
Diversified bonds can also mitigate risk. In 2022, we diversified our bond holdings so we held a smaller concentration of UK bonds, or ‘gilts,’ for clients and more international bonds via a G7 basket. This helped minimise the worst of the losses when UK gilts dropped in late 2022.
Sectors and regions
There are other ways we can give clients measured exposure for potential gains while managing risk through diversification.
For example, by investing in an Asian emerging markets fund with some exposure to China, we hope to benefit from the growth of the Chinese economy while not being overexposed to the risks involved in Beijing’s lack of transparency around state control and business.
Wealth diversification and property
Diversification is a practice that can benefit a broader wealth portfolio – beyond equity and bond markets. Private property, for example, can be a good asset to have alongside an investment portfolio, says Coutts Portfolio Manager Ajeet Ranjit.
“The advantage is you could feel less exposed as the value is unlikely to fluctuate as much as other markets,” he says. “Historically, property has provided inflation proof returns both in the value of the market and in yield on buy-to-let investments.
“Yes, the market is more difficult at the moment, but there are still potential opportunities and you have the bonus of a physical asset you can live in.”
Diversification and risk
Diversification could also help you identify where you may want to license more risk for the potential of higher returns. This is of course dependent on individual circumstances and goals, and diversification could be key to helping you understand what these might be, says Coutts Wealth Manager Myles Finnegan.
“We try to build it from the ground up with clients,” he says. “So we cover what they need for their cash flow and what they need for their family, and how diversification could help them manage risk. Once you’ve got that then you can take on riskier projects because you’ve diversified your risk appetite too.”
Our Private Markets team also offers eligible clients access to scale-up UK private company and real estate investment opportunities. These opportunities could provide further diversification to traditional listed market investments, as well as a way of backing some of the country’s most exciting businesses. They have the potential for higher returns, but do also carry additional levels of risk relating to the long-term and illiquid nature of the asset class. Fees and eligibility criteria apply.