Diversification as an investment belief: not putting all your eggs in one financial basket

A free lunch in finance

While diversifying stock selection can offer some mitigation against risks, there will still be systemic or market-wide risks that could have negative implications. These include inflation, rising interest rates, or political instability – all three of which we are seeing in 2022.

This is why we also look to diversify across all asset classes, as bonds, equities, property, and alternative investments will react differently to the same market conditions. Asset allocation is another of our core Investment Beliefs, and by spreading investments across different asset classes, we can mitigate against a variety of risks.

According to Joanna Stocks, Head of Liquid Alternatives: “Whether it’s asset allocation or stock selection, this is supposed to improve the outcome for investors. I should be able to construct a portfolio that's got similar levels of return for lower levels of risk.”

Therefore, diversification is sometimes known as the only free lunch in finance, she adds.

While it is important to acknowledge that diversifying cannot eliminate risk, by combining asset classes that don’t move in perfect sync with each other, diversification should lead to reduced volatility, and smoother returns.

Putting the belief into practice

We typically look to diversify your money at three levels: stock selection, the mix of fund managers and how we combine these funds into Portfolios.
Fund manager selection is absolutely key in ensuring diversification, and a lot of time and effort goes into making sure we only work with managers who have a demonstrable edge in this regard.

While some fund managers will be constrained in what or where they can invest (for example in a regional equity strategy), we would still expect them to be looking to diversify. According to Dr Sarah Ruggins: “these fund managers will still diversify across investment style sectors and industry factors to just name a few things they may be looking at. So, throughout their processes, they will reduce stock specific risk in their strategy by ensuring that there are various drivers of risk and return at play.”

We also look at how different fund managers work together in a multi manager fund. A recent example of this was in 2021, when we merged our Alternative Assets, UK Absolute Return and Multi Asset funds into our new Global Absolute Return fund. Part of the logic for the merger was that none of the original funds were diversified enough in their own right.

In creating this new fund, we removed some fund managers, rebalanced others, and added new fund managers. For the fund managers we removed, or whose holding was reduced, it was not necessarily just related to performance. Rebalancing was also done to ensure the fund was sufficiently diversified.

Ruggins added: “The result is a product with improved diversification across managers and strategies. In time, this smooths out volatility and delivers more consistent performance in a simplified structure. By ensuring clients remain fully diversified at every level, we believe this will help reduce minimise risk and volatility, without sacrificing long term returns.

This is the third article exploring our seven investment beliefs. Click here for an introduction to the series.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.