A one-stop shop for diversification

Investors are routinely advised to diversify – they are told the principle of not putting all your eggs in one basket is the key to managing risk and return. That’s fine in theory, but in practice, it prompts multiple questions. How much of your wealth should you hold in a given asset class? How should you spread your bets within each asset class? And should you change your allocations according to the shifting market environment?

One option is to outsource the job of answering those questions to one of the 20 or so investment companies in the AIC’s Flexible Investment sector. These funds are unusual in that they are not dedicated to a set asset class – UK equities, say, or fixed-income. Rather, their managers operate with an unconstrained mandate; they can invest across multiple asset classes as they see fit.

What you’re getting with these funds is a one-stop shop for diversification. Rather than having to invest in a bunch of different funds to spread your money around, you’ll get exposure to a range of different asset classes from a single fund. These funds invest in equities, fixed-income assets, commodities, real estate, private equity and more; sometimes they use derivatives too.

Moreover, these funds make the decision for you about what diversification should look like at any given time. Their managers raise or lower their exposures to individual asset classes according to their views about the outlook. They may even opt to hold significant cash balances if they’re feeling particularly risk-averse.

The downside of this arrangement is that you’re relying on the fund manager to make smart calls – to be in the right assets at the right time. Over-cautious managers may miss out on the returns generated by more adventurous asset classes. Equally, a more gung-ho approach may put too much of your money in harm’s way.

Certainly, the views of managers in the sector vary enormously. Research just published by Kepler Trust Intelligence charts the current asset allocations of four of the largest Flexible Investment funds: Ruffer Investment Company, Capital Gearing Trust, Personal Assets and RIT Capital Partners. All have cut exposure to equities over the past 18 months, Kepler points out, but by very different amounts. As a result, while Ruffer Investment Company held only 13.5% of its assets in equities by July of this year, RIT Capital Partners was still allocating 35% of investors’ money to this asset class.

When views diverge in this way, the inevitable result is divergent performance. The aim with all these funds is to preserve investors’ capital, especially over the medium to long term, but as Kepler points out, their returns in recent times look very different. At Ruffer, for example, the fund slipped 0.9% between January 2022 and August 2023; at RIT, the loss was 12.1%. By contrast, performance to date this year has been positive at RIT but has fallen back at Ruffer.

That, however, is not to undermine the point of these funds. Managers in the Flexible Investment sector are there to make decisions about diversification on your behalf, with a view to protecting your wealth. That’s a valuable service for investors who don’t feel comfortable – and that’s most of us – making all these decisions for themselves.

Kepler’s team of analysts put it this way: “While returns have been mixed since the markets began to sell off in early 2022, we think these defensive trusts still have a useful role to play in a portfolio.” They also point out that investors even have the option of diversifying within the sector – that is, combining several funds in order to gain exposure to their different strategies.