Why diversification remains so important

While minor periods of volatility are part and parcel of the world of investment, the markets have experienced a significant number of shocks that have required investors to be more proactive in adjusting their strategies and portfolios.

Sky high inflation, aggressive central bank action, the aftermath of the Covid-19 pandemic – all of these factors have played a big part in producing these shocks.

In addition, the stability of the international system has been buffeted by a number of geopolitical conflicts, not least the wars in eastern Europe and the Middle East.

These political and economic headwinds have created an investment landscape that has been increasingly difficult to navigate.

But, to an extent, we have seen this trend reverse in recent months.

The S&P 500 has gained 11 per cent since the start of the year as central banks have halted their rate hiking cycles, while the UK stock market hit a record high of 8445.80 on May 15.

Any developments in these conflicts are likely to bring fresh volatility to the markets.

However, any positivity that investors may be feeling should be tempered by the challenges that remain.

We are by no means out of the woods when it comes to market volatility, so investors must ensure that their portfolios are poised to withstand the difficulties the geopolitical and economic climate could produce in the months ahead.

As a result, diversification remains important, but more on this later.

The headwinds that could drag on investment portfolios

Potentially the most significant challenge facing the world of investment is the outlook for interest rates, which vary for each of the world’s major central banks as they try to balance inflation with economic growth. 

In the US for example, it looks like there are too many inflationary pressures at present for the Federal Reserve to consider cutting the base rate this month.

However, with inflation falling much closer to normality in the Eurozone, the European Central Bank recently voted to become the first major bank to reduce rates since its hiking cycle began to provide its economy some impetus.

The Bank of England looks set to follow suit at some point this summer, so market truisms would contend that currency and bond markets could undergo a period of uncertainty as interest rates are reduced unevenly across the global economy.

Meanwhile, events in the world of politics are also going to hold some significance in the second half of this year.

With major geopolitical players like Europe, the UK and the US all going through important election cycles, I expect there to be an uptick in volatility as investors anticipate and react to the results of these votes.

Diversification will continue to prove to be a useful tool in the months ahead.

As the world’s largest economy, the outcome of the election across the pond is likely to have the most substantial impact on the performance of investors’ portfolios, and so will be of particular interest.

Elsewhere, the conflict in Gaza threatens to spread into a wider clash, while Russia’s invasion of Ukraine is well into its second year.

Unfortunately, neither conflict is likely to come to an end in the near future and, due to the intrinsic link both regions have to the global oil markets, are likely to influence the performance of many of the major asset classes.

In turn, any developments in these conflicts are likely to bring fresh volatility to the markets.

Managing these challenges

When recent improvements in the performance of the financial markets are put into the context of these challenges, it is clear that investors will need to remain proactive and adaptive when it comes to managing their portfolios.

With this in mind, diversification will continue to prove to be a useful tool in the months ahead.

Indeed, if investors can create a portfolio built on uncorrelated asset classes, territories and sectors, they will be better place to mitigate the effects of volatility in certain markets and benefit from potential growth opportunities in others.

Opting for a mixture of traditional and alternative investments that perform independently of each other could also reap some rewards.

Therefore, investors could look to alternative investments like real estate, private debt and other non-traditional assets to help them navigate the economic and political uncertainty that could rock the global economy as the challenges discussed above play out. 

Regardless of whether they are managing risk, aiming for stable long-term growth, or looking to benefit from the speculative growth opportunities that volatility can provide, diversification could help investors to build a more resilient portfolio.

To briefly wrap up, recent market trends are providing some positivity, but the landscape remains fraught with uncertainty, and investors need to ensure they are ready for any market shocks that could be on their way.

Roddy Hogarth is the head of distribution at RAW Capital Partners