High-risk portfolios and volatility: the importance of diversification

Markets have had a difficult start to 2022. A period of slow growth appears to have taken hold and preliminary data on GDP trends in both the Eurozone and the US have failed to meet expectations. These are expectations that had already been revised in the preceding months. 

The reasons for the turbulence have been well-documented. The ongoing war in Ukraine has put further strain on an international economic system already buckling under the weight of growing inflation and ongoing issues related to Covid-19. These problems have, inevitably, had a knock-on effect on investment returns.

Since the beginning of 2022, the performances of all the main market indices have been disappointing. As you can see in the chart above, there have been poor returns across the board. All of the MSCI World, S&P 500 and Eurostoxx 600 are down year-to-date.

The importance of diversification

The performance of the major indices tells us a number of things. The first is that extraneous shocks can and will have a global effect on market performance, something investors should be prepared for and should expect as part of their long term financial plan. Risk is an inherent, important part of investing for the future and these periods of difficulty should always be viewed within their proper context. 

The second aspect to consider is the importance of diversification. A carefully calibrated spread between asset classes, geographies, currencies and industries can help to protect against some of the volatility caused by major events. We recently made some changes to portfolios to improve their resilience in the face of the current challenges, based on a number of factors identified by our team of asset allocation specialists. 

Our portfolios are made up of equities, bonds, commodities and cash – the exact spread of each depends largely on your risk level. Higher-risk portfolios will be made up of more equities, whereas lower-risk portfolios will feature bonds more heavily. Our team are monitoring markets daily, analysing opportunities and ensuring that portfolios remain balanced and appropriate for each investor’s risk level and financial goals. 

Taking volatility in its full context

We know that, in times of uncertainty like the one we’re experiencing now, investing can be a stressful endeavour. The crisis in Ukraine has come after two years of abnormally high volatility thanks to the Covid-19 pandemic. It’s been a turbulent time and we are fully aware of how concerning that can be for investors. 

The important thing here is not to panic. It’s important to remember that, though periods of volatility do arise, so too do periods of recovery and growth. During the early stages of the pandemic, for example, the S&P500 lost more than 30% in just one month, before recovering that loss in less than five months. 

Past performance is no guarantee of future returns, but it can help to see the current dip in the context of a volatile couple of years. Covid-19 was disruptive on a scale most of us haven’t experienced in our lifetimes and financial markets were not protected from that. Those who stayed the course largely saw their losses returned within a fairly short timescale; those that disinvested, in many cases, cemented their losses. 

Staying focused on your long-term investment objectives and thinking in terms of years rather than months can help put the current volatility into perspective. Also, chatting with your investment consultant and analysing your current position can help, particularly during turbulent periods for markets. Disinvesting during times of unrest has been shown to be a poor decision, serving to crystallise any losses made and risking missing out on the potential recovery.