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How to diversify your portfolio in the current environment

Equity and bond correlation is likely to be a short term phenomenon so you should still diversify your portfolio
October 17, 2022

Despite equities and bonds recently both falling you should still diversify your portfolio

Bonds still have a useful role in lower-risk investors portfolio and more recently have offered attractive yields

Alternative investments have not necessarily mitigated downside but some of these are now on more attractive valuations

Diversifying your portfolio is widely accepted as a key way of mitigating downside. At a very broad level, this has involved holding a mixture of equities and bonds, as their prices largely did not move together. But more recently both equities and bonds have sold off and been more highly correlated.

However, Rob Morgan, chief analyst at Charles Stanley, says: "We have seen an atypical period where bonds and equities have been correlated, both subject to the negative trend of rapidly rising interest rates. There have been previous periods where this has happened, but it is more usual for these asset classes to exhibit diversification benefits – and that could well be the case going forward. The benefits of diversification should start to reassert themselves as inflation peaks and interest rates start to fall away. At this point bond markets should start to provide some protection versus equities as investors worry about the possibility of a long recession. Correlations change over time, but principles of diversification remain. The traditional 60/40 [equity/bond split] portfolio has been through an exceptionally difficult period with a rapid adjustment to higher inflation but there is reason to believe that it is now in a good place. This principle was suspended during an era of very low interest rates but that is coming to an end."

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