Diversification is used by investors to reduce the risk of a portfolio by investing across a variety of asset classes that tend to perform differently in the same environment – this is a split between defensive (e.g. bonds) and growth (e.g. equities) assets.

The result is a smoothing of overall returns as poorer performing investments are offset by better performing investments. A simple example of this is the tendency for bonds to outperform when equities underperform.

Ever-lower interest rates are however driving valuations for nearly all asset classes to levels that are near or above long run averages at the same time, something that has rarely happened historically. This raises the question of whether relying on traditional diversification via a simple “set and forget” approach is appropriate. Especially given studies which show that bonds and equities exhibit greater negative correlation (i.e. move in opposite directions) when yields are falling than when yields are rising, and the US Federal Reserve is looking to normalize interest rates and raise their cash rate.

In the current market environment we’d suggest that not only will tactical asset allocation become increasingly important, but so too will active portfolio management and a focus on the risk of individual positions.

If you would like more information please call 1300 ELSTON or email info@elston.com.au and an adviser will be in touch.