Investors should rethink how they diversify their portfolios in 2017, Chelsea Financial Services managing director Darius McDermott argues, with funds such as First State Global Listed Infrastructure and Premier Defensive Growth suggested as ways to do this. 
McDermott says that he expects volatility to be higher in both equity and bond markets next year “given the ever-increasing amount of uncertainty in the world”.
“With no major asset class looking particularly attractive right now and markets too complacent for my liking, my first tip for 2017 is a simple one: make sure your portfolio is diversified,” he said.
“However, I don’t think the usual rules will apply to that diversification given bonds yields are already at very low, or even negative levels, and that stock markets are moving very much in tandem at the moment. So my second tip is to rethink the obvious and specialise more.”
When it comes to equity markets, McDermott thinks that infrastructure, insurance and India can offer attractive diversification benefits for investors.
“Infrastructure is a sector that has recently come to the fore as government policy around the world has begun to shift from monetary to fiscal stimulus,” he said.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
“Many projects are backed by governments and long in tenure, making the sector less volatile than the wider market. Yield can also be found. I like VT Infrastructure Income and First State Global Listed Infrastructure.”
As the chart above shows, the First State fund has outperformed its benchmark and average IA Global peer over the past five years. It holds five FE Crowns after showing superior performance in terms of stock-picking, consistency and risk control over recent years.
VT Infrastructure Income only launched in Jan this year so has a very short track record. It has made an 11.11 per cent total return.
McDermott adds that insurance is less talked about than infrastructure but offers many of the same characteristics, such as steady demand (as many insurance contracts are legally required) and a steady, albeit more modest, yield.
His preferred fund for this area is Polar Capital Global Insurance. Over the past five years it has made a total return of more than 150 per cent; while it has been very slightly more volatile than the MSCI World index over this time, it has recorded a higher maximum gain and a maximum drawdown that it 40 per cent lower than the index.
“On a country-specific basis, India is still my long-term favourite,” the managing director said. “The recent cash crackdown to tackle fraud has led to a slight sell off, but government policies are pro-business and it is an oil importer, not exporter, with a big domestic economy and fewer ties with the US than many other emerging markets.”
Performance of funds vs index over 3yrs
Source: FE Analytics
Ashburton India Equity Opportunities and GS India Equity Portfolio are his two picks for this area. As can be seen in the chart above, both portfolios have delivered significantly higher returns than the MSCI India index over recent years.
When it comes to bonds, McDermott says he prefers the two extremes of the fixed income spectrum.
“Bonds with short duration would be less sensitive to rising yields and inflation – if it starts to come through. And cash made from maturing bonds can be put to work straight away into others with higher yields. I like AXA Sterling Credit Short Duration,” he explained.
“At the other end of the scale, a higher yield may potentially compensate for the impact of any capital losses and inflation. I like Aviva Investors High Yield Bond and GAM Star Credit Opportunities, which are yielding 4.6 per cent and 5.2 per cent respectively.”
Finally, McDermott points out that the IA Targeted Absolute Return sector can be a good hunting ground for diversification, even though the peer group is a mixed bag of products and thorough research is necessary.
“It’s an area that always attracts negative headlines, but there are some very good funds to be found in this space,” he said. “I like Premier Defensive Growth, which may be a good one-stop shop for nervous investors with smaller pots of money, and Smith & Williamson Enterprise.”
Performance of funds over 5yrs
Source: FE Analytics
Premier Defensive Growth targets positive returns over rolling three-year periods and focuses on a number of investment themes such as discount opportunities, short-term catalysts and relative valuation.
FE Trustnet recently highlighted the fund as one that has made positive returns in each of the past five years as well as 2016 so far.
Smith & Williamson Enterprise, on the other hand, targets positive returns on a rolling 12-month basis. As the chart shows, it has made a higher return than Premier Defensive Growth but with more volatility.