Why now for deeper and enhanced diversification?
The Covid-19 pandemic has caused untold upset and disruption to almost every aspect of our lives and has long-lasting implications. Global economies and financial markets have also vastly altered as a result of the worldwide coronavirus lockdown. We believe this new landscape needs a deeper and defter investment approach.
The economic challenges ahead
When trying to manage market uncertainty and risk, while making a return on your money, investors usually consider diversification as the ‘golden rule’. Different factors tend to drive different asset classes. Therefore, by investing in more than one asset class, if one falls in value, another should compensate. Traditionally, that mix of asset classes would have included equities, bonds and properties. It’s the basic concept of not putting all your eggs in one basket. So far, so simple?
Not quite. Under ‘normal’ market conditions, traditional diversification has usually worked well over the long term. However, as we know, we are in far from ‘normal’ market territory. Amid the pandemic, we are seeing bonds and equities increasingly move in lockstep. Rather than rising or falling on specific earnings results or corporate data for example, assets are instead responding in similar ways to the same broad economic news or the latest central bank rescue package. Indeed, according to analysis by JP Morgan Chase, correlations across multiple asset classes are at 20-year highs.
The ‘fair weather’ limitations of normal diversification methods were starkly revealed during the global financial crisis (GFC) in 2008. During that period of extreme financial stress, the various asset classes fell in unison. Many investors in balanced or diversified growth funds, found themselves with less downside protection than they perhaps expected. What’s more, the unprecedented monetary support from central banks that followed, including quantitative easing, has left bonds and equites much more correlated.
So what’s the alternative?
In the current market environment, the traditional diversifying asset classes are not particularly attractive. Global equity markets look vulnerable to a correction, while bond yields are extremely low, in some cases negative. The property market meanwhile is struggling with the ramifications of lockdown. This is affecting the offices sector, as people work from home, and the already-beleaguered high street, given the greater propensity to shop online. So where can investors turn?
We believe now is an ideal time to cast the net wider, to include a much broader set of investment opportunities. And to consider alternatives and more sophisticated investment strategies. Enter enhanced diversification.
Broader, deeper, smoother, smarter
At Aberdeen Standard Capital, our Enhanced Diversification portfolios blend traditional growth and income asset classes, such as equities, bonds and property, with alternative investments. Our exposure to alternatives is through listed investment companies, which offer attractive yields, diversification from traditional asset classes, and some links to inflation. These alternatives include infrastructure projects, such as constructing hospitals, schools and roads, and renewable energy, like wind and solar farms. They also encompass real estate investment trusts (REITs) and commodities.
Additionally, we can take views on other key market drivers such as interest rates, inflation, volatility and currencies. These can all help generate returns at times when traditional asset classes may be faltering. We take both ‘long’ and ‘short’ positions in the portfolios too. This means we can invest in ‘relative-value’ strategies, which allow us to target positive returns irrespective of whether markets are rising or falling.
We believe our enhanced diversification approach is perfectly placed for navigating the current market uncertainty. It can help dampen volatility to make the investment journey more predictable. Through enhanced diversification of asset classes, we aim to protect on the downside, when markets are falling, while simultaneously offering broad market exposure to capture upside performance.
Final thoughts …
As we enter the second half of what has already been a truly extraordinary year, we expect further bouts of volatility and market stress. We could see a second wave of coronavirus infections and further lockdown measures across the world. There is also the upcoming US presidential election, which promises tension and intrigue, and the potential to upset markets. These are just a few of the events for which we can at least prepare. However, if 2020 has taught us anything, we should expect the unexpected.
With such heightened uncertainty, maximising diversification, among and across a broad range of asset classes and investment strategies can help manage risk more effectively. Ultimately, driving the potential for a more profitable investment portfolio.
PAM Awards 2020 Winner: Innovation for ED Proposition