The last month or so has been a miserable one for holders of most assets. So, unless you are the most hard-boiled gambler, protecting your capital in the face of what may turn from a correction to a rout will be a primary consideration at present.
If our seminar revealed anything, it is that there is no right way to diversify. Sure, there are plenty of mathematical principles to fall back on – not least Harry Markowitz’s Modern Portfolio Theory (MPF), which still provides the asset allocation models most professional investors use to balance risk and reward in their clients’ portfolios.
Yet despite the robust mathematics behind MPF, there is still no formula that can categorically inform perfectly portfolio diversification. As you’d expect, we regularly see DIY portfolios in our weekly clinic that are both over- and underdiversified. But, as recently pointed out in our newly launched sister product Asset Allocator, even among the professionals “opinion is split on precisely the optimum way to go about things”.
Indeed, like all aspects of investing, diversification is still subject to the pull of behavioural biases and the subjectivity of investment decision-making. Home bias and herding are two obvious culprits; the former will have meant suffering the depressing effects of Brexit uncertainty on the shares that are most exposed to the possible economic weakness a difficult departure from the EU may bring; coming too late to the great FAANG party would have proved equally painful.
Diversification should, of course, overcome these human impediments to successful investing – putting together baskets of assets that perform differently in different market and economic conditions, rising and falling at different points in the investing cycle but in aggregate steadily accumulating value over time. But even the most disciplined diversifier can find themselves faced with the same “impulses” that Jack Bogle once warned were the investor’s worst enemy – and the impulse to break one’s own rules and sell is strong right now, no doubt magnified by another bias, recency, which encourages us to think that what has just happened will continue to do so.
Perhaps it is the same bias that has encouraged some analysts to describe the UK market as “close to uninvestable” at the moment, after substantially underperforming global indices since the referendum on the back of huge outflows from UK equity funds, and historically cheap. If, as is highly possible, Brexit turns out to be less disruptive than the bias-laden horror stories suggest, then that could prove a huge buying opportunity – and diversifying away from UK exposure too late could be a badly-timed impulse mistake.
