Investing for the unexpected: Why diversity is the antidote to unpredictability | Discretionary Asset Manager - Aberdeen Asset Management
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February 7, 2017

Investing for the unexpected: Why diversity is the antidote to unpredictability

Few people predicted how 2016 was going to turn out. Given Brexit and a Trump presidency and the bottoming of the interest-rate cycle, further surprises for financial markets could come thick and fast in 2017. What’s the answer for investors? Diversification, suggests Mike Brooks, Head of Diversified Multi-Asset Strategies.

What surprises should investors be braced for in 2017 and beyond?

It’s important to remember just what a year of surprises 2016 was – not only in terms of the result of the US election and the UK’s European Union (EU) referendum, but how markets and policymakers acted. We saw interest rates turn negative, resulting in an estimated $15 trillion of sovereign debt trading at real negative global yields interest rates[1]. The US Federal Reserve confounded expectations and only raised interest rates once. But at the same time, we saw both equity and credit markets deliver positive results across the globe.

However, 2017 is the year  that speculation turns to action. Donald Trump is likely to establish major policy proposals in his first 100 days and the UK government will start giving concrete detail on its plans to leave the EU. Mix in China’s economic slowdown and elections in France, Germany and the Netherlands and you see there is potential for major market shocks and surprises. Many of these factors have implications for global trade, so we could see sharp gyrations in performance by market and by industry sector.

So how can diversification help?

Despite their continued strong performance in 2016, we believe this is no time to have all your assets tied up in conventional bonds and equities. More importantly, this is no time to rely on market-timing to get you into the right asset class at the right time. Our view is that taking a long-term view on a wide variety of different asset classes is the key to achieving return and reducing downside risk. There are asset classes now that weren’t available 10 or even five years ago – including insurance-linked securities, peer-to-peer lending, renewable and social infrastructure – which can help reduce reliance on equity markets for growth and reduce risk in a portfolio by lowering volatility and downside risk.

Are we seeing greater levels of diversification among investors?

Well, a good example is the Yale Endowment Fund, a US$25.4 billion fund[2] which is the largest source of funding for Yale University. It has reduced its exposure to domestic US equities from 60% 30 years ago to around 5% today. Many of the world's other most sophisticated institutional investors have also diversified their portfolios making greater allocations to asset classes such as infrastructure, direct lending and emerging market bonds.

The good news is that almost anyone can achieve a similar ‘institutional’ level of diversification through a diversified growth fund (DGF).

What’s the benefit of a diversified growth fund over a DIY approach to portfolio diversification?

First, a DGF can provide access to an array of asset classes, typically a dozen or more, that would be hard and costly to replicate fund by fund. Second, the portfolio should be constructed to ensure that the blend of asset classes is optimal in terms of return and risk. So some asset classes will be chosen for their strong growth potential, others for their steady yield, and others for a return that’s less affected by stock market sentiment or interest rates. By blending multiple return drivers that are largely independent of each other, a diversified growth fund is far less vulnerable to external shocks than, say a pure equity fund.

Are the benefits of diversification coming through in performance?

In our experience, yes. The Aberdeen Diversified Growth Fund was launched in November 2011 and invests in a broad blend of real assets, special opportunities, and higher yielding bonds and equities. It has achieved its rolling five-year internal target return of Libor + 4.5%*. But volatility has consistently been half that of the MSCI World Index, ranging from 3-6% rather than 6-13%[1]. Aberdeen Diversified Growth Fund performance:

chart for hub magazine Feb 17

How should investors view the role of a DGF in the current climate?

A DGF should function as the long-term core of a portfolio, giving you the stable growth potential you need to weather external events, while still keeping you on course to meet your investment goals. Having that solid core in place should make it easier to handle whatever unpredictability the next few years will present.

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[1] Source: Aberdeen Asset Managers, BPSS, Thomson Reuters Datastream, SMEP, 31 October 2016

[1] Source: World Gold Council –  ‘Gold in a world of negative interest rates’, March 2016

[2] Source: Yale Investments Office, June 2016

PLEASE CONSIDER THE RISKS

The following risk factors should be carefully considered before making an investment decision:

  • The value of investments and the income from them can go down as well as up and your clients may get back less than the amount invested. Past performance is not a guide to future returns.
  • Investing globally can bring additional returns and diversify risks. However, currency exchange rate fluctuations may have a positive or negative impact on the value of your clients investment.
  • Emerging markets or less developed countries may face more political, economic or structural challenges than developed countries. This may mean your clients money is at greater risk.
  • Bonds are affected by changes in interest rates, inflation and any decline in creditworthiness of the bond issuer. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may not be able to pay the bond income as promised or could fail to repay the capital amount used to purchase the bond. Where a bond market has a low number of buyers and/or a high number of sellers, it may be harder to sell particular bonds at an anticipated price and/or in a timely manner.
  • This Fund can use derivatives in order to meet its investment objectives. This may result in gains or losses that are greater than the original amount invested.
  • A full list of risks applicable to this Fund can be found in the Prospectus.

Important information

For professional investors and financial advisers only – not for use by retail investors.

The above marketing document is strictly for information purposes only and should not be considered as an offer, investment recommendation, or solicitation, to deal in any of the investments or funds mentioned herein and does not constitute investment research as defined under EU Directive 2003/125/EC. Aberdeen Asset Managers Limited (‘Aberdeen’) does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials.

The Aberdeen Diversified Growth Fund is a sub-fund of Aberdeen Funds, an authorised unit trust. The manager is Aberdeen Fund Managers Limited. Nothing herein constitutes investment, legal, tax or other advice and is not to be relied upon in making an investment or other decision. No recommendation is made, positive or otherwise, regarding individual securities mentioned. This is not an invitation to subscribe for shares in the Fund and is by way of information only. Subscriptions will only be received and shares issued on the basis of the current Prospectus, relevant Key Investor Information Document (KIID) and Supplementary Information Document (SID) for the Fund. These can be obtained free of charge from Aberdeen Fund Managers Limited, PO Box 9029, Chelmsford, CM99 2WJ.

Risk warning:

Risk warning

The value of investments and the income from them can go down as well as up and your clients may get back less than the amount invested.

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