The Week: In a crisis, diversification matters more than ever

The first six months of 2022 may have seen all asset classes sell off, but diversification has still helped preserve investors’ returns.

  • 14 out of 16 asset classes suffered losses in the first six months of the year
  • Greater asset class diversification would have contained losses to less than 10%
  • Portfolios more concentrated on certain assets have been detrimentally impacted the most

Just in case beleaguered investors needed reminding, almost nothing has helped protect portfolios in the first half of 2022. Analysis from Asset Risk Consultants shows 14 out of 16 asset classes suffered losses in the first six months of the year, with only commodities and gold providing a positive return. In this environment, diversification would seem to provide little protection, but in reality, it has helped minimise losses.

Concurrent falls in both bond and equity prices are rare. ARC points out that equities haven’t seen a similar six-month fall since John F Kennedy was president of the United States, while US sovereign debt recorded the worst first six months for a calendar year since the US Constitution was ratified in 1788. For nine of the 16 asset classes it was the worst performance since ARC began monitoring in 2003.

It would be easy to conclude that this has rendered diversification ineffective and that asset allocation hasn’t mattered very much. However, the group’s research showed the majority of investors saw a decline of 10% in their portfolio from January to June, but greater asset class portfolio diversification would have contained losses to less than 10%. It also showed that private client managers performed better than the average, with the average portfolio down 7.3%. It said portfolios more concentrated on certain assets have seen the most detrimental impact.

ARC’s Graham Harrison says: "Concentrated portfolios have come into vogue over recent years but what the last six months have shown is that even significant historical outperformance can be rapidly reversed. Investors seeking a smoother ride should carefully consider the words of Buffett that diversification is a protection against ignorance.”

If anything, the recent market rout should remind investors of the importance of diversification. It would have taken extraordinary predictive powers to foresee the war in Ukraine, the potency of the inflation threat and the central banks’ aggressive response. Diversification is the only weapon investors have had to protect themselves. Even if an investor had managed to predict the direction of travel, moving a portfolio wholesale into gold and commodities could have left them very exposed had the war, or inflation, or interest rates taken a different turn. 

Crises can serve as a potent reminder that the old rules still apply. Diversification hasn’t been very important over the past decade: investors have just needed a handful of bonds and a handful of technology stocks to make hay. However, it’s when the going gets tough that it really matters.