Diversification has never been more crucial than in the current market crunch. With some assets dropping markedly while others have held firm, perhaps the best way of mitigating losses has been to make sure that one’s investments are as uncorrelated with one another as possible.
If done right, the combination of assets with different characteristics ensures that the losses made by a falling area have a greater chance of being counterbalanced by the gains of another, winning asset.
But true diversification has become increasingly hard to come by, according to Tom White, investment research manager at Bestinvest, who described it as “an increasingly rare commodity”.
“With individual stock markets dominated by giant global companies, their fortunes have become increasingly intertwined, so spreading your investments around the world doesn’t carry the same benefits it used to,” he said.
While it might be complicated to find true diversification geographically, Trustnet collected the thematic areas that experts think should have greater weightings in a portfolio than they usually do.
Investors can diversify with the energy transition
Economic and environmental reasons are pushing Europe and the UK to move away from fossil fuels and to gain independence from the volatile global oil and gas markets, according to White. A key part of this change will be moving to renewable energy, which is an area that has the potential to grow regardless of the wider market.
“In particular, wind, solar, hydro and bioenergy – and an ever-growing number of specialist funds have sprung up to capitalise on this move,” he said.
However, investors need to be selective. While shares in companies such as turbine manufacturers are highly correlated to equity markets and come with similar volatility, wind farms and solar parks themselves through investment companies are a more attractive option, he said.
These have the double benefit of attractive income, paying around 4% or 5% each year, “which appears attractive even compared to the high-yielding UK equity market and is substantially higher than that available from global equities or bonds,” said White.
On a total-return perspective gains have been positive, but more moderate, he added.
In this space, White recommended three trusts: The Renewables Infrastructure Group, Octopus Renewables Infrastructure and SDCL Energy Efficiency Income.
Of the three, only The Renewables Infrastructure Group managed to beat its the renewable energy infrastructure peer group, as the graph below shows.
Performance of trusts vs sector over 1yr
Source: FE Analytics
“Infrastructure is a core asset class with good inflation linkage
Ben Yearsley, director at Fairview Investing, is a “big fan” of infrastructure and has invested in the asset class for the past 15 years.
“It might be odd to say infrastructure is an underweight area but only recently has it been added to many portfolio risk mapping tools,” he said.
“I have always viewed it as a long term core asset class, with decent income and capital growth prospects and good inflation linkage. The inflation link is often a direct link to the cash flows of the underlying assets. What’s not to like?”
While it probably won’t be ever be the top sector when markets are roaring ahead, it can be a nice defensive asset in tougher times such as these, said Yearsley.
He recommended First Sentier Global Listed Infrastructure, which is “by far the market leader, however there are a few other options with the likes of Macquarie making a fresh push into the UK market with Global Listed Infrastructure”.
Performance of fund vs sector over 1yr
Source: FE Analytics
Real estate is an interesting option
According to Tom Sparke, investment manager and director at GDIM, real estate is an interesting option in inflationary times and can provide a degree of diversification in portfolios.
“Although the rising rate environment may make some property yields less attractive, a reliable income stream is still a tempting option for many investors,” he said.
“Looking at the traditional real estate areas, I would be hesitant to hold a significant overweight as many of these will be cyclical and may suffer in a recession, which looks likely in many places. That said, employment remains strong so the expected recessionary dip in office demand may not be so pronounced in this cycle.
“Outside of these, there are interesting options in more niche areas. Residential housing is investable and provides excellent diversification from equities and bonds, but the returns are not hugely generous.”