Investors can never avoid hearing how they should keep their portfolios diversified — so that, when equities are struggling, this may be offset by better-performing bonds, and vice versa.

Traditionally, a diversified portfolio was expected to comprise equities, bonds, passive funds and potentially another vehicle such as property. But now investors have many more types of vehicle to choose from.

A quick, unofficial Twitter poll shows most people believe that to have true diversification one needs to own more than seven funds.

Remember that investing is quite subjective — everyone has a different attitude to risk

I recently came across a ‘managed’ model portfolio that held seven funds. Further investigation revealed two generic UK funds, two global funds and a few managed funds. An even deeper look found that several of those funds held similar stocks, more or less correlated with each other. So the portfolio was merely a more expensive route to owning virtually the same things as could have been obtained from just four funds.

In order to achieve true diversification, therefore, perhaps the focus should not be on quantity but instead on what the funds actually hold.

Management style

Shore Financial Planning director Ben Yearsley says it depends on how one looks after client money.

He adds: “With a multi-asset approach you will have maybe three to four funds but, if you do proper investment management, you will probably own up to around 20.”

Meanwhile, Chelsea Financial Services managing director Darius McDermott says that, in order to get true diversification, one must invest across asset classes, geographic regions and investment styles.

“This means one needs, preferably, a combination of equities, bonds, property, commodities and alternatives from all over the globe,” he says.

There is a reducing effect as more and more asset types are added

Importantly, as we have seen over recent months, investors require diversification across styles (that is, growth and value), McDermott adds.

“This much diversification may not suit everybody, but having an element of each will be important,” he says. “Also, remember that investing is quite subjective — everyone has a different attitude to risk, and preferences for one sector, region, asset or another. So portfolios will look very different from one person to another.”

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Wingate Financial Planning financial planning director Alistair Cunningham agrees that it is not the number of funds that is important but what is held in them. One concern, he says, is false diversification.

“I have clients with diversified portfolios with just one or two multi-asset funds. But equally I see individuals, particularly from self-selected portfolios, with dozens of UK equity income funds, for example.”

This suggests investors may think that owning multiple funds means they have a selection when in fact these may be similar investments in different guises.

One needs, preferably, a combination of equities, bonds, property, commodities and alternatives from all over the globe

Cunningham says: “We consider that in the region of 13 asset classes are desirable for diversification, and this can be simplified, to explain to clients, down to the main four: bonds, equities, cash and ‘other’. But also we can drill down further and classify these assets in more ways.

“The basic tenet of investment means diversification can reduce risk and/or increase expected returns, but there is a reducing effect as more and more asset types are added.

“It is possible to model where the reduction in return expected is greater than the benefit in reduction in risk.”

Investment amount

McDermott adds that, while diversification is about balancing a portfolio to cope with volatility, it can also come down to money.

“The number of funds held within portfolios will vary depending upon the amount invested,” he says.

“As a rough guide, you may expect to have approximately 10 funds in a portfolio of over £30,000, and 15 to 20 in one of over £100,000.”

Over the years, multi-asset funds have been touted as having cheaper diversification, but for now the importance should be put on looking into each fund more deeply, rather than taking them all at face value.

This article featured in the September 2021 edition of MM. 

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