The importance of diversification

If the Brexit-inspired turmoil of the past week has taught us nothing else, we should all now appreciate the importance of having a diversified investment portfolio. Investors with exposure to the wrong shares – banks and housebuilders – have suffered but will have been protected by other holdings that have proved much more resilient. Amongst collective funds, investors in mid-cap UK funds have been hit hardest, while funds with investments in markets such as North America have actually made gains.

It’s probably too early to say that the dust is beginning to settle – particularly given the daily political shocks – but more than a week after the referendum result, we can at least start to reflect on lessons learned and to think about how to move forward.

One of those lessons is that closed-ended funds can be a comfortable (or at least less uncomfortable) place to be during a market crisis. In the panic immediately after the referendum result, investment company managers didn’t have to worry about where they’d find the cash to pay out to large volumes of investors anxious to redeem their shares.

Indeed, it has been noticeable in the days since then that leading investment advisers suggesting safe haven funds to ride out the Brexit crisis have invariably picked out investment companies, particularly from the mainstream UK and Global sectors.

This is not to suggest that investment companies have been immune to market volatility – far from it. Mid-cap funds, property funds and emerging markets funds in particular have suffered setbacks, while some of the more international funds have risen.

We’ve seen share price moves but we’ve also seen shifts in the discounts and premiums at which many investment companies’ shares trade relative to the value of their underlying assets. Some funds sit on significantly cheaper valuations than a week ago, while others now look much more expensive.

Some investment company analysts believe these valuation shifts represent an opportunity for advisers and investors prepared to take advantage. For example, at Stifel Funds, analyst Iain Scouller argues that in reality, nothing much is going to change for quite some time following the referendum result.

“Any UK exit from the European Union is unlikely before 2019 at the earliest, if it ever actually happens,” Scouller argues. “Therefore, we think in the meantime it will be business as usual for most corporates – the initial knee-jerk reaction in some segments of the fund sector has thrown up some interesting valuations and opportunities.”

Scouller suggests advisers should now be on the look-out for such opportunities. Amid the hysteria, there will be strong funds run by sound management teams with good long-term prospects that have slipped to bargain-basement valuations. In which case, savvy advisers and investors might decide now is the moment to make an investment.

A cheaper valuation does not, of course, prove anything in itself. Rather, it represents a starting point for analysis of the fund. Still, in the turmoil of the past week, nothing fundamental has happened to investment companies’ assets, or to the managers of those assets; and the structure of investment companies means that negative sentiment can only have had an effect on the share price – not the underlying portfolio. Now might be the time to be brave.