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Diversifying could increase risk

IFAs trying to reduce the risk within their clients’ portfolios by diversifying across different asset classes may be inadvertently increasing their clients’ risk exposure, according to research by Saltus Partners.

Portfolio manager Dan Kemp says the research shows that different asset classes such as equities, bonds and property have seen a sharp increase in correlation, meaning that efforts to diversify portfolios could increase risk.

The research, based on data from Bloomberg and Merrill Lynch, looks at correlation between 21 different asset clas-ses, including gold, oil, large equities and US dollars.

Over the past 10 years, just 35 asset classes have delivered “highly correlated” returns but in the past three months, 228 out of a possible 420 asset combinations were highly correlated.

Kemp says that increased correlation also negates the benefits of investment techniques such as stockpicking and tactical asset allocation.

He says: “Most risk management systems rely on long-term data and as such may have missed the recent increase in correlation.

“We are looking at a period where proving or adding value is difficult for managers and where there are higher levels of risk than face value would suggest.”

Hargreaves Lansdown senior analyst Meera Patel says: “Inv-estors need to be a bit more savvy when it comes to diversification, focusing on which areas are cheap and investing according to their needs.”



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