16 years of returns: History’s lesson for investors

Past performance is not a guide to future performance and may not be repeated. Source: Source: Schroders, Datastream as of 31 December 2021. Equity: MSCI AC World Total Return Index. Property: UK IPD Index. Hedge funds: HFRI Funds of Funds Composite Total Return Index. Cash: 3 month Sterling LIBOR. Global HY: BofA Merrill Lynch Global High Yield TR Index; Sterling IG: IBoxx UK Sterling Non-Gilts All Maturities. Govts: Barclays Global Treasury Index. Property: UK IPD Index. Commodities: Bloomberg Commodity Index. EMD: JPM GBI-EM Composite Index. ILS: Swiss Re Cat Bond Index.  All show total return either in local currency or currency of denomination.

What are the benefits of diversification?

The table reflects how the fortunes of different assets often diverge.

Take the historic performance of equities, which typically make up a large portion of investors’ portfolios. Their performance is often unrelated to (or not “correlated” with) the performance of government bonds. In other words good years for equities, such as 2013 (+26%), 2019 (+28%) and 2020 (+14%), were also comparatively poor years for bonds (–4%; +4%; +2%).

The opposite is true in that good years for government bonds tended to be poor for equities. In the case of 2008, for example, which was the epicentre of the financial crisis, government bonds were the highest-performing asset class returning 10%, while equities were the worst, falling 39%.

The table also shows how some asset classes, for example cash, demonstrate relatively consistent nominal returns year after year. These may not be exciting, but they offer defensive characteristics where investors seek to protect themselves from the more volatile categories where performance leaps about the chart year on year.

The benefits of diversification can be described in various ways:

Managing risk: A crucial imperative for investors is not to lose money. There is risk with every investment – the risk that you receive back less than you put in or the probability that it will deliver less than you had expected. This risk varies by the type of investment. Holding different assets mean this risk can be spread. It could also be managed by you or by a professional, such as a financial adviser. Specialist fund managers can also allocate money to help manage risks.

Retaining access to your money: The ease with which you can enter or exit an investment is important. Selling property can take a long time compared with selling equities, for example. Holding different types of investments that vary in terms of “liquidity” (the ease of buying and selling) means you can still sell some of your investments should you suddenly need money.

Smoothing the ups and downs: The frequency and magnitude by which your investments rise and fall determines your portfolio’s volatility. Diversifying your investments can give you a greater chance of smoothing those peaks and troughs.

Johanna Kyrklund, Global Head of Multi-Asset Investments at Schroders, said: “For me, the merits of diversification cannot be emphasised strongly enough. I’ve been a multi-asset investor for more than 20 years and have inevitably faced some pretty turbulent spells for markets. Each time, the ability to nimbly move between different types of assets has better equipped me to navigate those periods.”

“Diversification, if carefully and constantly managed, can potentially deliver smoother returns; it’s a key tool to help in balancing the returns achieved versus the risks taken.”

Too much diversification? There is no fixed rule as to how many assets a diversified portfolio should hold: too few can add risk, but so can holding too many.

Hundreds of holdings across many different types of investment can be hard for an individual investor to manage.