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Find the right mix

Helen Pow asks if it is time for investors to move away from diversifying their portfolios

As one of the stars of the UK stockmarket, Invesco Perpetual top-performing income and high income fund manager Neil Woodford’s sometimes radical opinions count.

The latest? In a recent Sunday Times interview, Woodford criticised the common investing philosophy of “diversifying” a portfolio. But other UK fund managers are opposed to writing-off the method.

Woodford believes most asset classes in the UK have become closely correlated and are getting increasingly expensive, particularly property, which he claims is overvalued. People investing into every asset class simply because diversification is the done thing are being overcautious and will see poor returns, he says.

Instead, Woodford recommends investors look for cheaper and more traditional funds which are not dependant on the economic cycle. He says they should steer clear of commodities, which he claims are not investments because they do not deliver dividends, and property funds.

Axa Investment Office senior manager Colin Nelson says diversification depends on the type of investor – it is not for everyone but for many it is an effective method of investing. He says risk-adverse people are happy to diversify their portfolio because it limits volatility. But he understands why people chasing the top-performing funds may be unimpressed by the recent performance of some assets classes, and therefore less keen to buy into them all.

He says: “Diversification is about reducing volatility, combined with an increased outright potential for return. Yes, it reduces those highs, but the lows will also not be so low. It is good for the individual who is more risk adverse. If you are looking for performance you have to be prepared to take a risk.”

Fidelity Multi-Manager managing director Simon Ellis says despite the fact markets have become more correlated you cannot write-off diversification.

He states that, historically, people actively shifted between different developed markets such as Japan, Europe and the UK, but during the past few years those markets have become increasingly correlated. Ellis wonders whether this correlation is a temporary phenomenon or a permanent phenomenon. He says: “I agree it is more expensive than it was two years ago but that is not to say there is no value in there. There are pockets of value in every single asset class.”

Barings Asset Management chief investment officer Michael Hughes agrees that it has become harder to achieve diversification in developed equity markets. He says: “With equity markets being highly correlated it is more difficult to find diversification but there are other ways of getting diversification.”

Hughes suggests moving into global markets is an alternative to traditional diversification.

He states: “UK-based investors traditionally put most equity in UK markets but there is an argument saying it would be a better way of approaching risk by going for global equity. It might make more sense having half in global and half in UK equity.”

Different manager skills and different investor styles also contribute to diversification according to Hughes.

Nelson agrees the style of investor and the level of expertise they plug into are important points to consider.

He says: “There is place for diversification both within and across assets.”

Nelson says, in equity funds investors can choose from large cap, mid cap and small cap and in terms of property, investors can diversify between geographical regions such as the UK, Europe and Asia.

F&C Multi-Manager fund manager Tom Caddick agrees that diversification for the sake of diversification is rubbish.

He says: “Diversification purely for diversification’s sake is not a good thing. There needs to be a reason to buy an asset other than diversification.”

He suggests investors should choose funds depending on their investment timeframe and the value of the asset.

Ellis agrees, and says rather than simply choosing a fund that is cheap now or will be in the next six months Fidelity takes a longer-term view of the value of an asset class. According to Ellis, choosing a fund based on price and perceived value is not a good idea. He says: “Neil’s recognised expertise is first class but I do not think diversification is something people should avoid. It is down to the timescale and finding decent value between them, but to write-off an asset class because it is too expensive is too general.”

Caddick says that while Woodford is wary of investing in property, F&C believes it can still deliver lucrative returns.

He says: “In the long term we are positive on commercial property. It brings with it strong and diversified income streams and means for capital growth and upward potential for rental review. We are not expecting the same returns as the past few years but through income streams there is the potential for income growth and capital growth at around or above inflation and still high returns.”

So it seems many fund managers believe diversification is still a useful tool. Even if some asset classes are underperforming, the comfort and peace of mind of having your finger in many pots is still attractive to investors

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