A good time to be diversified

With markets in disarray, and uncertainty the dish of the day, diversification may be one of the only friends we have. As the saying goes, ‘there is no free lunch in finance’, but a well-diversified portfolio will at the very least ensure you live to eat another day.

On the way down, diversification serves to spread risk and reduces the volatility impact of any one asset class on your portfolio. At the bottom, and on the way back up, it frankly helps to increase your chances of being right and to find those new opportunities in emergence. Many eggs in many baskets makes for prudent action, especially in such uncertain times.

Especially so as we move into what is framed by many as a very different ‘new world’. How we work, shop, travel and do business have all changed dramatically and it is argued that these changes could re-write the paradigm completely.

This global threat to life is set to change the world in ways that will become apparent only later and a well-diversified portfolio will ensure clients are well positioned to seize these new opportunities when they finally appear. And they will. It is more a case of when and where, not if.

On the way down

It is these moments that many are preparing for when constructing a portfolio. That moment when perceived risk becomes a reality. Whether it be a comprehensive spread of equities, bonds and some property positions, or simply a spread of regional equity markets, developed and or emerging, you can achieve the risk diluting benefits of diversification quite easily. This positions you well when markets correct, or crash like they have done recently.

Being diversified versus NOT since 17 January 2020

Source – FE Fundinfo Analytics

Differing opinions

Price action and market behaviour represent the collective opinion of millions of investors who are speculating on what they believe is happening and will happen moving forwards. In times of crisis, these predictions become harder to make with conviction and our estimations (and prices thereafter) are merely guesses and differ across regions and asset classes.

So far, investors have used a combination of cases and deaths, lock-down protocols and monetary/fiscal response as a measure for the future prosperity of a nation and its economy, and this has been priced into the behaviour of markets that differ considerably in opinion.

Everybody agrees that GDP contractions are coming but the time to recovery is still a point of great contention and this can make the allocation of capital across markets that much harder.

Equity investors are optimistic and continue to bank on the notion that the world will return to normalcy within the next 6-12 months whilst bond markets are pricing in a much longer and withdrawn, lethargic recovery. This can be seen in how markets have responded to date, with equity markets falling less than half what we have seen in yield reductions on 10-year Treasuries and Gilts. 10-year yield reductions show massive demand for longer duration, safe-haven assets. Yields have not been this low since 2008.

Equity and bond markets since 17 January 2020

Source – FE Fundinfo Analytics

As is always the case with the unknowns, it breeds opinion.

Markets are forward looking and operate solely on opinion and expectation, but these expectations are much harder to set in the throws of a crisis. Especially one as unprecedented as this. The point being nobody knows and so it’s best to increase your chances of being right, and reduce your chances of being wrong, by diversifying strategically across a number of asset classes and categories.