Why diversification matters

Diversification is a key tenet of our investment philosophy and one of the best insurance policies you can have to protect yourself against uncertainty in investment markets.

The importance of diversification

If the last few years have taught us anything, it’s that we live in an uncertain world. Covid, Russia’s invasion of Ukraine, conflict in the Middle East, shifting political power /allegiances, elevated inflation, recessions, extreme weather events and a cost of living crisis are just a handful of examples of what consumers, businesses, economies, markets and investors have had to contend with.

A number of these events have culminated in the current high interest rate environment that we find ourselves in, and with banks paying around 5.5% plus on deposits this has led some to question the need to invest elsewhere.

However, this question (and strategy) goes against one of the key principles of investment, diversification.

No-one knows with 100% certainty how different economies will perform in future, what markets will deliver the best or worst returns, what inflation will do, or in what direction interest rates will move.

When it comes to investing, one of the best ways of managing this uncertainty is through diversification.

Diversification is about reducing risk, and providing more stable returns over the long term, by ensuring your portfolio is invested across a range of asset classes (cash, fixed income, property, shares and alternatives).

Each of these asset classes have different risk and return characteristics that play an important role in a portfolio.

However, diversification doesn’t stop there. It is also important to ensure that your portfolio is not overly exposed to any one area.

For example, investing 40% of your portfolio in fixed income should help to reduce fluctuations in the value of the portfolio. But, if this 40% is invested in just one bond, it means that almost half of your portfolio is exposed to the fortunes of just one issuer (or company).

This is why it is also important to ensure your portfolio is not only diversified across different asset classes, but also across different companies, issuers, sectors, countries, styles, themes, strategies and sizes.

However, diversification is more than simply combining some term deposits with some shares, or at the other extreme collecting a wide range of investments with no attention paid to the structure of the overall portfolio.

At Craigs, our dedicated asset allocation, investment committee and research teams work together to ensure all these factors are kept in balance and that these principles are translated into our investment guidelines, strategic asset allocations and model portfolios.

This is an excerpt of an article published for clients only. Craigs Investment Partners clients can view the full version of this article by logging in to the client portal.

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