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Time to diversify?

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4 December 2018

David Prosser discusses positioning your investment portfolio for uncertainty in the future.

What a difference a year makes. This time in 2017, investment banks, brokers, asset managers and other investment analysts were publishing upbeat outlook reports following a year of consistently strong market returns. Some of those reports, it is fair to say, proved a little over-optimistic as volatility returned to world markets during 2018; this year’s versions, looking ahead to 2019, mostly make much less encouraging reading.

In truth, you could probably distil the advice handed out in these look-ahead papers into just one word: diversify. The consensus view on 2019 is that there is no consensus – the unpredictability of the political and economic drivers of the markets in the year ahead, from President Trump’s next moves on international trade to the outcome of Brexit, mean uncertainty will dominate. Picking out the prospects for any one asset class against that backdrop is extremely challenging.

How, then, to position an investment portfolio for this environment? On the one hand, it might be tempting to move into cash, avoiding more risky assets altogether, but with interest rates so low, that’s hardly attractive and may in any case mean missing out on upside in some markets. On the other, only the bravest investors will be comfortable with betting the house on any single area.

All of which brings us back to diversification. If the old adage about not putting all your eggs in one basket is true of any year, 2019 looks to be the one. Mitigating risk over the year ahead will require careful portfolio planning that makes good use of a range of asset classes.

The investment company industry offers two routes to achieving this goal. The first is to look at the Flexible Investment sector. Their managers operate with unconstrained mandates and the freedom to invest across a variety of asset classes, including equities, bonds, property and alternatives. They provide a spread of investments tailored by the manager to reflect his or her current views about the prevailing market conditions.

Option two is more suited to investors who want greater control over the specifics of the diversification process and are prepared to go down the DIY route. It is to build a portfolio of diversified assets through holdings in a spread of investment companies. These will probably include more traditional equity funds, but the diverse closed-ended fund universe also offers exposure to a range of other assets, many of which are uncorrelated with equity and bond markets.

Options to consider include infrastructure funds, private equity vehicles, funds investing in various types of property and the growing debt sector, which includes funds investing in everything from peer-to-peer finance platforms to convertible bonds.

Many of these non-conventional assets are illiquid, which is why it makes sense to invest through an investment company rather than an open-ended fund. Managers need the freedom to run their portfolios without the distractions of inflows and outflows, which can be significant during periods of volatility.

Get the balance right and 2019 starts to look a little less scary. Diversification is a concept we often talk about in investment, but the next 12 months is a time to put that into practice. Investment companies could be the best route for doing so.

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