The role of diversification as a tactic for smoothing volatility

We often say that successful investment management is really all about effective risk management.

One of the ways we manage risk in portfolios is through diversification. Now, diversification has become rather an overworked term. While to some it means a scattergun approach to investing, we apply it slightly more scientifically, in the quest to reduce as many of the correlations and covariances between asset classes and types of security within those asset classes, as possible. This may sound a bit technical and indeed properly applied, it is.

But when the market experiences one of its existential crises of confidence, such as occurred last month during the CV crisis, then a properly diversified portfolio should suffer a much lower proportion of the volatility, or loss, of the market generally and therefore be in a good position to benefit from the recovery which usually follows.

We apply techniques of diversification at two levels, across portfolios and within the underlying core funds that we use to build those portfolios. This in effect gives us two bites of the same cherry, two chances to get the diversification piece right.

One of the ways we diversify at fund level is by analysing the complete capital structure of a potential investee company. With both credit and equity expertise in-house, we have the ability to identify where the best opportunity lies within a company's capital structure. It could be, for example, that a loan security or a bond issued by a company might provide the best option. With its fixed term of interest payments and obligation to repay the capital, this sort of security has many attractions but a low potential for capital growth over and above its nominal issue price. Further down the capital structure, in terms of risk, the equity securities issued by the same company, might have the much greater scope to reflect the growth potential but a low likelihood of any capital return, in the event of company failure.

Diversification is therefore a key technique in ensuring the long-term preservation of a client's capital and that is usually rule number 1, 2 and 3 of the portfolio mandate a private client will give us.

To learn more about the Church House approach to Portfolio Management please follow this link or indeed contact us on 020 7534 9870 (London office) or 01935 382620 (Sherborne office).

Important Notes

The content in this post does not constitute an offer or solicitation to any person in any jurisdiction to purchase or sell any investment.  We recommend prospective investors contact us to discuss their personal circumstances before making any investment decisions.  No information in this post should be construed as providing financial, investment or other professional advice. 

The value of investments and the income you get from them may fall as well as rise and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.

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