Are you really getting diversification from your funds and investment trusts?
Diversification is widely considered to be an important part of investing. You should ensure your investments are spread across a variety of assets, in different sectors and a number of regions so one piece of negative news doesn’t result in disproportionate damage to your portfolio. Achieving this is not always as easy as you may think.
Investors may assume that by selecting a range of funds or investment trusts across different sectors they will have achieved diversification within their portfolio.
This is not an unreasonable assumption but it may not be one which is correct. Many funds will have a degree of crossover, which may not be entirely obvious at first.
For example, if you have a global fund, a US fund and a mixed investment 40-85% shares fund in your portfolio, it is very likely they all have Apple, Alphabet and Amazon within their top 10 holdings – meaning you’re effectively paying three different people to invest in the same stock and, worryingly, have inadvertently become dangerously overexposed to the fortunes of a handful of companies.
UNDERSTANDING WHAT YOU ARE REALLY INVESTED IN
Anastasia Georgiou, director of product management at Morningstar, says: ‘It’s really important to be able to see what you are actually holding and where there is overlap. People think that because they have 15 funds in their portfolio they are automatically diversified but they don’t see more than the top 10 holdings.’
For example, you might have an emerging markets investment trust and a FTSE 100 tracker in your portfolio, two seemingly very disparate investments. Yet both will have a very high exposure to the commodities sector, leaving you at risk if the oil price falls or there is a change in sentiment towards gold or copper.
Avoiding these pitfalls isn’t easy. One of the main obstacles is that fund managers rarely reveal more than the top 10 holdings in their portfolio, making it difficult, if not impossible for investors to determine the full level of overlap between the various funds they hold. In addition, holdings which are detailed are generally at least four weeks out of date – although they may not have changed in that time.
Thomas MacMahon, senior investment analyst at research group Kepler, says: ‘Up-to-date full portfolio holdings are rarely made available to investors but you can learn a lot from the information usually included on the factsheets.’
FOCUS ON THE FACTSHEET
A factsheet is indeed a good starting point when trying to ascertain how much overlap there is between your funds. The first thing to look at is the top 10 holdings list – obviously there is no point choosing two separate funds which share eight out of 10 of their largest investments as, in many cases, this list accounts for half of a fund’s assets or even more.
A factsheet will also detail the fund or trust’s allocation to different sectors such as financials, commodities or technology.
You might think your global fund is giving you access to a decent spread of different companies only to realise that it has 70% of its assets in the technology and telecoms sector, clashing somewhat with the racy technology fund you had specifically selected to provide that exposure.
Similarly, you will also find on a factsheet details of the fund’s allocations to various countries. Again, you might reasonably assume a global fund will provide access to a range of regions only to discover it has 60% of its money in US-listed stocks, rendering your S&P 500 tracker unnecessary.
Macmahon says: ‘Funds with very similar sector or country exposures will tend to behave in similar ways, irrespective of the stocks they pick. This is not a hard and fast truth but, in the absence of detailed information, is a good sense check.’
AVOIDING BEING OVER-EXPOSED TO ONE AREA
If a fund does have a heavy exposure to a particular country or sector, that is not necessarily a problem, you just need to ensure that not all of your funds have the same bias, leaving you over-exposed to those areas.
MacMahon adds: ‘The descriptions of a fund’s style can also be informative. If two funds have objectives which discuss finding undervalued companies they are likely to both be value funds, which means they behave similarly even if the stocks they pick are different.’
To check your portfolio more closely, online tools can often be a help. Ratings service Morningstar has an X-Ray tool which analyses the level of overlaps between the funds you hold, helping to flag up if there are any stocks to which you are over-exposed and revealing the overall allocation to sectors and countries across your portfolio.
Georgiou says: ‘It would be great if more fund companies made their websites more user-friendly to help investors; it is not always easy to see how a fund will fit into your portfolio.’