One of the current discussions within the financial services sector is how to invest in an environment where the correlation between shares (equities) and bonds (fixed income) has grown, potentially reducing investment diversification, and in turn increasing the overall risk of the portfolio.

Investment Analyst, Alex Dempster shares his insight into how to manage this risk inside your investment portfolio.

When creating a balanced portfolio, traditionally, a split between 60% equities and 40% bonds has been considered a reasonable approach to balance growth and risk. This is because equity and bond returns tend to be uncorrelated. The idea that a 40% holding in bonds in a portfolio will counteract a downfall in the stock market has been a cornerstone of investment management for decades. And it has often worked quite brilliantly, with one asset class picking up the slack when the other is struggling – or at least softening the blows through the income generation of bonds.

Recently, we have seen the typical pairing of equities and fixed income investments become similarly correlated - but this isn’t the first time! Back in 2008/09 we observed the same correlation as a result of the Financial Crisis. 

So, given the increased correlation between equities and bonds, how do we now position portfolios to deal with this and create more resilient investment portfolios?

It all starts with diversification, a risk management strategy which combines a wide variety of investments within a portfolio. A diversified portfolio contains a mix of asset types and investment vehicles in an attempt at limiting exposure to any single asset or risk.

The equities/bonds split is a form of this and there is still a place for both within portfolios. We can also look to allocate capital to alternative types of investments, such as property, infrastructure, and commodities. Another example is Structured Products, which have an element of capital protection built in, and we have been using them successfully to diversify client portfolios for decades now.

As Independent Financial Advisers - diversification has been a key strategy of Lowes over our entire history. In addition, we have the advantage of having an expert, in-house investment team looking after our clients’ portfolios. They monitor the markets on a daily basis and identify the investments which can offer the best returns as well as those that can spread risk within portfolios. As well as finding the best funds, our clients also need investments that offer an element of protection as part of that risk diversification – this is just one area we can help in.

When it comes to investing, one thing we do know is that we don’t know what is going to happen next, but by following our investment philosophy we can prepare our investment portfolios as best we can to weather the storms and make hay when the sun shines.

Please note: The value of investments and the income they produce can fall as well as rise. You may get back less than you invested.