Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by BH Global. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.


investment trusts incomeWe explain why diversification on its own is not a panacea for portfolio construction…


A little learning is a dangerous thing, or so the proverb goes.

Alexander Pope used the phrase in his Essay on Criticism in 1709shortly before the South Sea Company was founded, sparking a bubble which ruined the fortunes of thousands of investors when it burst, spectacularly, eleven years later.

Clearly Pope did not take his own advice, for he was among them – writing to his friend Lady Mary Wortley Montagu, in August 1720, to recommend that she buy South Sea stock even on the eve of its collapse, as he had been assured that it would ‘certainly rise in some weeks, or less’.

While our readers – like most serious investors – put a tremendous amount of work into constructing their portfolios in a sensible fashion, there is no harm at all in considering the uncomfortable warning that his proverb provides, particularly when it comes to the perceived benefits of diversification.

The benefits of diversification have been repeated so often that there is a risk that they are, to some degree, a panacea – taken for granted.

A recent study by Kepler Trust Intelligence found, for example, that while most of the 130 investors we spoke to have no ‘target allocation’ toward equities or bonds, and no real consistency in terms of how often they look at their portfolios, an overwhelming majority (80%) were running large, varied portfolios with more than 15 constituents, and cited diversification as the most important factor they consider for portfolio construction.


Think diversification, think correlation


Diversification is the only free lunch, according to another famous author, but as the Covid induced market sell off – a tide which dragged all anchors – showed diversification only works if investors combine assets which are not correlated to one other.

But, while 73% of our survey respondents said that the correlation between their investments is something they consider before making any allocation in their portfolio, finding asset classes which fit this description is increasingly difficult.

As we have discussed in the past, equities and bonds have shown increasing correlation in recent years, investors may need to cast a wider net to achieve portfolio diversification which has any meaningful effect on portfolio stability.


Tools for striking the right balance


So, if a diversified portfolio balanced between risk and return is the aim of most of our readers, what is the best route to achieving this?

As mentioned earlier, the traditional answer to this conundrum would be to blend equities and bonds in a portfolio, perhaps in a 60/40 split. However, this solution has become increasingly unsatisfactory in recent years. As correlations have risen – especially between long-only bonds and developed market equities – the risk management benefits of this strategy have waned.

A better option is to look at alternative assets. Real asset classes such as property and infrastructure have proved to be key sources of uncorrelated total returns in the past few years, with their emphasis on income as the primary driver of returns.

At the same time, esoteric asset classes such as private equity have produced strong NAV growth in a period when global public equity markets have largely moved together.

In all these cases, the investment trust structure’s inherent liquidity gives private investors access to diversifying investments, which over the long term should reduce risk.

As we saw in February and March, over the short term, building a diversified portfolio without considering correlation would not have helped.

In this regard, a lesser-known alternative to consider are funds that explicitly aim to produce positive returns regardless of what is going on in the rest of the market.

One such example is BH Global Ltd, a listed global macro hedge fund which aims to deliver strong risk-adjusted NAV returns in all market conditions.

It invests in a range of trading strategies across multiple asset classes to achieve this, with the cumulative outcome being its historic tendency to generate returns irrespective of the direction of bond or equity markets.

This was exemplified in the first and second quarters of this year. As the coronavirus pandemic plunged global equity markets into negative territory, BH Global saw strong returns, with its NAV outperformance of equities reaching over 40% on a rolling monthly basis at various points during the crisis.

Importantly, one equity markets started to recover, BH Global continued to generate positive returns, which have now reached 14.8% (to 5th June 2020).

BH Global’s uncorrelated pattern of returns can be seen over the longer term also. Since launch in 2008, the trust has experienced only one down year (in 2015, losing 1.32% GBP in NAV terms). In the ten years to 31 March 2020, the trust delivered compounded NAV returns of 4.8% p.a., with annualised volatility of 6%.

As a tool to add genuine diversification to a portfolio, rather than simply adding more funds which will move in tandem with one another, this track record suggests that BH Global could be one of the sharper options in the box.


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