Miles Geldard, manager of the Jupiter Strategic Total Return Fund, looks at diversification through multi-asset investing.
Diversification goes back to the Talmud, which advised us 2,000 years ago to divide our money into three parts, invest a third in land, a third in business, and to keep a third in reserve.
Such balanced portfolios are remarkably modern because they emphasize that diversifying risk is more important than maximising return.
Investors can rarely eliminate risk, but have refined their techniques to reduce risks associated with returns.
Naturally the aim of any diversified strategy is, by mixing assets, to give a balance between expected risk and return for long-term investors.
Benjamin Graham advised investors to split portfolios equally between shares and bonds, and to rebalance periodically.
This restrained savers from excessive exposure to equities should they rise to dangerous heights.
Britain’s institutions invested heavily in diversified growth funds in recent years. Take-up among Britain’s defined benefit pension schemes doubled to 40 per cent in the previous 12 months, according to a survey in June 2010 by Aon Consulting.
Diversified Growth Funds invest in assets including commodities, high yield bonds and equities and have typically offered the prospect of “equity-like” returns over an economic cycle.
Those returns are often expressed in terms of superior returns relative to LIBOR over the medium to longer term.
But in the financial crisis, diversifying by investing across assets did not work. Instead of benefiting as rising bonds contrasted with falling equities, clients suffered because different asset classes fell together.
“Risk-on, risk-off” trading made this trend worse. It became apparent a genuine spreading of risk was necessary.
In our opinion, a good way to achieve that diversification, and to pursue performance, is to have a large number of small active positions.
For example, a short position in the South African rand has recently been a source of returns for Miles’s team.
The pursuit of performance can also lead to targeting absolute returns, where one common aim is to deliver a “cash plus” return.
Other example objectives for absolute returns include a target of the retail price index plus 4% annually, or a fixed target of 8% per year.
Absolute return products often seek to limit volatility – typically between one-third and a half of the figure for equity markets.
Absolute returns contrast with relative strategies, where the objective is to beat a benchmark.
Multi-asset investing also actively allocates risk exposures based on changing market environments.
Despite this, multi-asset investing has yet to become fully mainstream. Investors often want to know whether equities or bonds are the best bet this year, rather than consider both. They also fear that diversification will hit returns.
A multi-asset absolute return strategy can give pension schemes one solution to delivering returns, while seeking to reduce some of the risks associated with investing exclusively in equities.
However, they take on additional risks caused by absolute return funds’ investment philosophies.
Institutional investors can potentially gain diversification, a focus on absolute returns, and lower volatility.
For professional investors only
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The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change.
They are not necessarily those of Jupiter as a group and readers should be aware that they should not be interpreted as investment advice.
Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.