Many young investors may not be used to the unpredictability and volatility seen in markets this year, but to Ben Seager-Scott, head of multi-asset funds at Evelyn Partners, they have served as a stark reminder of the importance of maintaining balance in your portfolio – particularly as top-performing areas of the past decade such as technology and government bonds have been hit especially hard.
But properly diversifying your portfolio is easier said than done. He said there are five important considerations to bear in mind when it comes to rebalancing.
- Bonds now offer little protection against falling equities
Underlining just how rare it is for equities and bonds to fall together, April 2022 was only the fourth month in 50 years that both the S&P 500 and US Treasuries were down at the same time. June was the fifth.
“This reflects the rapid shift to rising rates from the low interest-rate environment that has prevailed since the financial crisis,” said Seager-Scott.
“Some parts of the market have been hit far harder than others. Those investors that maintain a diversified portfolio, spread across a range of asset classes, sectors and geographic regions, are likely to have fared better in the recent rout. They are also more likely to have experienced a smoother ride over the long term.”
- Maintaining a balanced portfolio is harder than it looks
Creating a diversified portfolio is relatively straightforward – but maintaining it is a lot more difficult.
Seager-Scott said investors often get caught up in the drama of financial markets – by panicking when volatility spikes, for example, or by being lured into speculative assets.
They can also become dangerously attached to some investments, hanging on to previous winners long after they are past their best, or keeping high weights to top-performing areas in the hope their success will continue indefinitely.
“This means it is easy for portfolios to become unbalanced even if they start out well diversified,” the head of multi-asset added.
“For example, many investors may have found themselves with significant weightings in technology after its recent strong run. While that may result in periods of strong returns, it makes for a volatile ride and some hair-raising short-term losses.”
- Balanced portfolios help protect against volatility
“Ensuring that a portfolio has a balance at all times brings an important discipline to investing. It encourages investors to sell out when prices are high and reinvest when prices are low,” said Seager-Scott.
For example, he said that if a portfolio has 20% invested in the energy sector, and strong performance causes this weighting to rise to 25%, it makes sense to rebalance that back to 20%.
The alternative is that energy becomes a larger part of the portfolio: this can leave it poorly diversified and increases risk, leaving it more vulnerable to any change in market conditions.
Seager-Scott added: “While in theory it may be possible to time your exit from a particular sector – selling out when it looks like its fortunes are weakening – in practice, this is fiendishly difficult to do. Even professional investment managers who are monitoring the market day to day and have abundant information at their fingertips rarely attempt it. The market often anticipates change for individual companies and sectors ahead of time, which makes it tough to get ahead of it.”
A recent example came during the pandemic, when markets started to recover only weeks after the initial sell-off, just as most of the world was entering lockdown.
- There is an emotional advantage to regular rebalancing
While there are plenty of challenges associated with portfolio rebalancing, there are some immediate benefits as well.
Seager-Scott said that having a well-structured portfolio means that you don’t worry as much about the market highs and lows or whether it’s a good time to invest
“An investor who knows what their portfolio should look like for the long term doesn’t have to worry about the day-to-day market mood,” he added.
- What does a balanced portfolio look like?
It has become more difficult to build a balanced portfolio in recent years, as unusual monetary policy from central banks has distorted the performance of equities and bonds, which have become more closely correlated. But Seager-Scott said this doesn’t mean it is impossible.
“We see the market eventually reverting to more normal patterns of diversification now that the monetary policy environment has shifted. Therefore, we believe it is important to include areas such as commercial property and infrastructure, as well as maintaining a balance within each asset class – having exposure to corporate debt, for example, alongside government bonds.”