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Diversification still works

Call it the coronavirus crash. Today’s equity investors will rarely have suffered more volatile and frightening slides in the value of their assets.

The spread of COVID-19 across the globe and the subsequent lockdowns imposed to protect people’s health is unprecedented. In many ways it feels like a world war. No wonder that the valuations of most companies have plunged.

It’s at times like this that advisers look for safe havens for their clients – highlighting the importance of diversification for portfolios. A diversified investment process shows its value in difficult periods like today, when the impact of the crisis is not merely dictated by national borders or GDP.

The fundamental principle of being diversified is to have a spread of assets that act differently to each other. This helps to ensure that an unforeseen event like the coronavirus does not hurt an entire portfolio.

Diversification helps to reassure more cautious clients and allows investment managers to remain calm and emotionally unbiased in the face of market setbacks, precisely because different assets behave differently – with some designed to perform well during market downturns.

Strategically positioning investments across a diverse range of asset classes, currencies, sectors and geographical regions is crucial when diversifying portfolios. It greatly reduces the chance that one event will harm all of your holdings.

We constantly run our portfolios through over 20 of the biggest market shocks through modern history (e.g. the 2008 financial crisis), as well as the worst hypothetical scenarios we can imagine. We couldn’t have predicted COVID-19, but we’ve seen the size and direction of such market shocks before and we factor these tail risks into our portfolio process.

The big question facing advisers and their clients now is whether it’s too late to diversify. We think the answer is a resounding no, with various trends and opportunities presenting themselves in different regions and asset classes.

Investing globally is a key part of the diversification process. Global investing, though, is not always straightforward, and to avoid the pitfalls it’s important to understand the additional risks that come with such an approach.

One area that has been hit hard by the coronavirus is emerging markets, with most markets having crashed in the last two months. Fearful investors might be inclined to run for the hills, but we believe emerging markets fulfil a vital role in a diversified portfolio, providing exposure to the highest-growth regions of the world.

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