How has investment diversification changed over the years?

When it comes to investment diversification, it's easy to assume that nothing has changed over the years, but this is a very big assumption (and wrong). Looking back, our attitude to diversification and the way we achieve this have changed dramatically since the 1960s. This has allowed investors to spread their risk, reduce overexposure, and maximise returns while injecting a degree of protection. You will be surprised how much the approach to diversification has changed!

 

Historical perspectives on diversification

 

We will now examine how diversification has evolved and changed over the years and what the future holds.

 

Traditional diversification

 

Traditional diversification means something different to investors today, but if we look back to the period between the 1960s and 1980s there was a very different attitude. There were no high-tech systems, no Big Data analysis and certainly no robo-advisors. For many people, diversification was simply a balance between stocks and bonds (in local markets), mixing different asset classes to reduce overall risk. Equity risk was often limited to different industries within a single market with no deep analysis of performance data.

 

Modern Portfolio Theory

 

Between the 1980s and the 2000s, we saw the emergence of Modern Portfolio Theory, which Harry Markowitz initially introduced in the 1950s. While a little more technical, the idea was simple: to achieve diversification by mixing assets that had low correlations with each other, i.e., were loosely connected or, in some cases, moved in different directions. This was the start of the modern-day trend toward more technical diversification and has made a significant difference to both protection and returns.

 

Global diversification

 

During this period, we also saw the introduction of global diversification through technology and new investment vehicles. Investment trusts and unit trusts, for example, provided a means of diversifying investments into foreign markets. This reduced country-specific risk and saw investors increase their direct exposure to international markets.

 

Technology and innovation

 

From the 2000s to today, technology has dramatically enhanced diversification for institutional and private investors. During this period, we have seen significant focus and funding in areas such as:-

 

Exchange Traded Funds (ETFs)

 

While initially seen as a means for professional investors to gain exposure to specific countries, sectors and different asset classes, private investors now use ETFs. They have similarities to unit and investment trusts but tend to trade closer to asset value and are tradable in real time during traditional market hours. If you name an industry, investment trend or asset class, there is likely to be an ETF for you to consider.

 

Alternative investments

 

As investors seek ways to diversify their portfolios, there has been a considerable increase in demand for alternative investments such as hedge funds, private equity and real estate. Carrying on from one of the modern portfolio themes, many have a low correlation with traditional investments such as stocks and bonds, further enhancing diversification. Many alternative investments also carry beneficial tax breaks, central to long-term tax planning.

 

Digital transformation

 

Another ongoing development heavily related to technology is the digital revolution and the introduction of trading platforms, complex algorithms, and different means of investing, such as fractional shares. There has also been an increase in the use of robo-advisors, which can create personalised investment strategies for individuals. These are controversial as they remove an element of human interaction, which many investors still favour.

 

Future trends

 

As we stand today, there are many options for those looking to diversify their portfolios and introduce a new degree of protection while also looking to maximise their returns in a sensible manner. Some of the more recent trends to emerge include:-

 

· Environmental, Social and Governance (ESG) investment

· Cryptocurrencies and digital assets

· Advanced risk management

 

While many see diversification as a relatively static topic, once you begin to dig a little deeper, it is much more fluid than you might first assume.

 

Summary

 

Looking back, different diversification strategies emerge on a regular basis, but recently, the 2008 financial crisis and the pandemic have prompted many investors to look more deeply into this topic. The development since the early days of simple equity and bond diversification is certainly dramatic, with technology playing a major role.

 

How do you approach diversification for your portfolio? Is it even a topic that you consider?

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