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Diverse dangers

One of the big debates that has taken place over recent years concerns the desirability of adopting a diversified investment strategy. Popular wisdom has it that, by building a portfolio of diverse asset classes, investors would be protected against any setback in a particular area.

There is some evidence that this can happen but it is by no means conclusive. The shakeout in markets a year ago saw corporate bonds falling as much as equities, with only high-grade Government debt providing some protection.

What did happen was that many advisers encouraged their clients to hold some quite esoteric asset classes.

As well as property becoming very popular in the mid-1990s, commodities, funds of hedge funds and even agriculture all earned a place in portfolios. And there was quite a scramble to embrace the new approach. Looking at what has happened over the past six months suggests that this policy is at best flawed and, some cases, downright dangerous.

Taking a range of funds that would give you access to various asset classes, it is most interesting to discover that the best performer over this period has been UK mid-caps. Europe follows a close second and in third place is Asia, emerging markets and gold. Agriculture trailed the field.

The past six months have been exceptional – exceptionally good for the majority of investors. It is important to be realistic and accept that the gift of foresight is not granted to investors, so knowing that March 2009 was the time to leap aboard the UK mid-cap bandwagon was never an option. Indeed, it is possible to interpret such statistics in a different, and entirely less positive way. Perhaps the real concern should be that UK mid-caps have moved ahead too far too fast.

It happened that I was looking at some investment trust statistics recently. These were also very telling.

The best-performing trust over the past 10 years by a wide margin was JP Morgan Russia Securities – and this despite the fact that the fund had halved in value during the past 12 months. It was launched originally as a Fleming vehicle in the wake of the collapse of communism, so it did benefit from an extra-ordinary change to what remained a powerful nation, despite all the upheaval.

Even so, it is hard to imagine any sensible portfolio manager putting more than a very small percentage in the trust a decade or so ago – and then top-slicing regularly.

What the statistics did show is that investment trusts can be a very useful way of accessing illiquid asset classes. I am not just thinking about difficult markets like Russia. Private equity and property look far more suited to a closed-ended structure, particularly given the way that dealings in a number of open-ended property funds have been suspended.

The risk is that, at times of stress, the discount to value widens and values themselves become difficult to justify.

It seems likely that investment trusts may find themselves being accessed through a widening number of platforms. The RDR may influence this but they do enjoy different characteristics to open-ended funds and they are arguably becoming more risky as the range of assets and instruments they can hold widens.

And we have an increasing number of ETFs and struc- tured products to contend with. This is an area worth exploring more. An adviser’s life seems set to become even more complex.

Brian Tora (brian.tora@ is principal of the Tora Partnership


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