'Diversify and think long term' is not always best advice

Published on Friday 27 March 2009 20:00

OVER the past few weeks we have been bombarded by advice on optimising our tax allowances and where the best investment opportunities lie. More than ever the focus of many articles has been on the importance of diversification and the long-term nature of investments.

These are both traditional themes of the investment industry and after the year we have all endured, and more importantly in the prevailing climate, it is appropriate to scrutinise their validity.

First, diversification. It is generally stated that by spreading your investments across the different asset classes, you reduce the risk in your portfolio, and so avoid the extremes of a downturn.

Well, a cursory look at the returns delivered by many balanced or managed funds last year – the very funds that are supposed to practise such diversification – suggests that something is not quite right. In many cases, the returns generated were very closely linked to the performance of the FTSE 100, with a marginally reduced loss towards the end of the year.

So diversification across the asset classes did little to stem the losses.

A handful of actively managed funds served investors significantly better over the same period by becoming as defensive as possible. By building cash balances, buying exposure to the rising gold price and refusing to adhere to the traditional asset splits, these funds significantly outperformed their peer group.

If a small number managed to do this, what does that tell us about the rest?

And second, the long-term concept of invested capital. Any asset-backed investment needs to be viewed in terms of years rather than months in order to deliver decent returns. That said, there is a growing suspicion that much of the talk about long-term returns implies a perhaps less-than-proactive approach to investment. Buy equities today because the market is low, and in future years you will be glad you did, in simple terms.

Perhaps, but what if the stock market falls a further 30 per cent from current levels? Perhaps the market is low for good reasons, rather than being cheap, as is often suggested.

Would an investment into the price of crude oil at current levels not provide a better opportunity, for example?

What I am really highlighting here is the massive importance of not simply putting investments in the drawer and hoping that eventually they will prove to have been worthwhile. One thing that last year should have taught us all is that the world has changed significantly.

As investors, we therefore need to adapt accordingly. By doing nothing, too many people saw the value of their investments plummet last year. There is nothing in the rules that prevents taking a stance against the worst of market conditions.

It is for precisely this reason that the majority of new client assets for which I am responsible remained in decent cash accounts last year. It might not have provided diversification, but it has allowed them to start this year with improved balances as opposed to being devoid of a third of their portfolio.

Of course, with interest rates at current levels it is now time to think beyond cash, and that will present a whole new set of challenges. It is a given that mistakes will be made, but through a commitment to vigilance and a responsiveness to change, it is also possible that decent returns can be achieved.

&#149 Ken Taylor is director of Mackenzie Taylor Wealth Management