Spreading your bets really does work
David Prosser analyses investment trust returns since “independence day”.
Does diversification really matter? Every financial adviser and investment commentator will tell you about the importance of building balanced portfolios, but it’s not always easy to see how theory translates into practice.
Well, take a look at research compiled by the Association of Investment Companies (AIC). It’s based on the returns that investment fund sectors and individual trusts generated in the four weeks from Liberation Day on 2 April to 25 April. Of course, that’s a very short period – and investors should remain focused on the longer term – but the list makes fascinating reading.
Of the top 20 investment trusts on the AIC list, just three invest in global stock markets. The rest all offer exposure to a range of alternative assets. Property funds are particularly well represented, alongside investment trusts investing in renewable energy infrastructure and in the hedge fund sector.
Top of the list is 3i Group, the private equity trust with a return of 15.4%, followed closely by Urban Logistics REIT, which invests in the UK’s warehousing and logistics industry, with a return of 13.0%, while Bluefield Solar Income managed 11%. There were also some interesting individual stories DP Aircraft I in the Leasing sector, for example, was up 11.9%.
It’s a powerful lesson about the importance of diversification. We often think about portfolio construction in terms of building exposure to a range of stock markets – or in relation to the split we want between the traditional asset classes of equities, fixed income and cash. But if you’re prepared to look across a wider range of asset classes – to seek out much broader diversification, in other words – this can sometimes prove hugely valuable.
One reason for this is that alternative asset classes are often ‘uncorrelated’ with their more traditional counterparts. That is, changes in the returns generated by these investments are not connected to the ebbs and flows of performance from equities and bonds. The drivers at play in many of these areas are very different.
Investment trusts are the only option for most investors who want exposure to these alternative asset classes.
David Prosser
Alternatively, these asset classes offer a negative correlation – that is, they tend to outperform when equities, say, are doing poorly. One good example is renewable energy and infrastructure; these asset classes are doing well partly because of the economic turbulence that has rocked stock markets – investors expect interest rates to fall to support the weaker global economy, which is helpful for funds that hold long-term assets valued with respect to rates. They are also relatively insulated from the tariffs and trade war.
All of which is to say that the answer to the question at the top of this article is a resounding yes. And also that many investors don’t have as much diversification in their portfolios as they might think, even if they’ve built up a decent spread of stock market holdings.
The question, then, is how to secure broader diversification? Here, investment trusts can play a key role. In practice, investment trusts are the only option for most investors who want exposure to these alternative asset classes.
That’s because the structure of investment trusts is particularly well suited to investing in these areas, which tend to be illiquid and require long-term commitments from asset owners. The closed-ended nature of an investment trust allows it to make such commitments and to manage illiquidity, while still offering its own investors the ability to buy and sell its shares at a time of their choosing.
The lesson for investors from recent weeks is clear. Broadly based portfolios provide a comforting cushion at times of stress. Investment trusts with alternative asset exposure can be a valuable way to achieve that breadth.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
