Go forth and diversify

How, then, to protect yourself from the current bout of market ups and downs, let alone from a potential correction? Well, if you’re keen to stick with those trackers through thick and thin, how about adding some different types of funds to your portfolio so that you’re not holding all your eggs in one basket. Tracker funds can work well as the foundation stones of an investment portfolio, but some diversification will make the whole structure stronger.

In which case, you need funds that aren’t simply buying more of the equities that you already hold inside those trackers. That means steering clear of vehicles invested in larger companies on developed markets, which dominate the indices that global trackers aim to mirror. Instead, look to add exposure to smaller companies and holdings in emerging markets.

In both cases, investment trusts offer some good choices. The structure of an investment trust is well-suited to small cap and emerging market equities, which can be illiquid and more volatile. Specialist managers run fixed pools of assets and don’t have to worry about money flowing in and out of their funds.

It’s also important to diversify beyond equities, particularly into asset classes where prices don’t tend to move in line with the stock market. Infrastructure assets and renewable energy projects are good examples; both offer a good mix of income and potential capital gains, often providing stable returns linked to inflation over long horizons. As such, they provide an excellent counterpoint to equity funds.

Again, investment trusts offer a convenient route into these asset classes – the only route, typically, for most retail investors. These are private market investments – that is they’re not quoted on a public exchange – and can’t easily be bought and sold, particularly at smaller deal sizes. But an investment trust provides investors with continuous liquidity through its stock market listing, even when it is investing in these illiquid assets.

Debt is another area worth considering. Conventional investment wisdom is that it makes sense to hold bonds alongside equities to manage risk. That’s not wrong, though bond markets have shown they too can be volatile in recent years. You might consider further diversification through private credit, with a number of investment trusts now offering access to assets such as direct loans to companies. There are worries about a bubble in the private credit market too, so tread carefully, but this is another example of where investment trusts can support a diversification strategy in the face of mounting risks.

There is no right answer – your choices will depend on your investment objectives and your attitude to risk. But the important point here is not to trust everything to tracker funds. These low-cost investment vehicles certainly have a place in many investors’ portfolios, but they come with their own dangers.