How diversification can add protection against market volatility

The Nutmeg team


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Volatility is something that can affect specific assets as well as broader sectors and indices. All Nutmeg portfolios are designed to help offset volatility when it occurs.

 

Below we can see how Nutmeg’s fully managed portfolio at risk level 8 performed when volatility rose in the markets as the Covid pandemic went global in March 2020.

  • For most of 2019, the overall performance difference between Nutmeg Risk level 8 and the FTSE 100 was marginal.  In fact, when there is a lower level of volatility in the market, the benefit of diversification is generally less visible.
  • In March 2020, with markets impacted by the Covid pandemic, this diversification benefit started to become more apparent with the Nutmeg portfolio dropping much less than the FTSE 100. This is where we can observe the effect of the greater diversification of the Nutmeg portfolio, compared to the FTSE 100 with its narrower range of assets.
  • In the subsequent market rebound from April 2020 onward, the Nutmeg portfolio also saw a better recovery than the FTSE 100.
  • The outperformance during high volatility periods was positive during both up and down market-movements and again highlights how diversification helped, when compared to a more concentrated allocation focusing on a single country such as the FTSE 100.

Source: Nutmeg/MacroBond

Using diversification to manage risk

Diversification is a key approach in helping to manage risk – balancing your weightings in asset classes to reach a level of risk that is deemed acceptable and manageable for your risk appetite. The concept of diversification, and its assistance in times of market volatility is straightforward: If you were to invest your entire portfolio into one sector which then took a 50% drop in price, you would then need it to rise by 100% just to get back to the price level at which you invested. By diversifying into different asset classes, regions, countries or sectors – you are less reliant on very specific assets which might perform more sporadically.

At Nutmeg we offer different levels of risk to choose from based on your investment goals. Equities can experience more volatility and so are seen to carry higher risk, whereas bonds (government and corporate debt) are usually much less volatile and carry lower risk. The risk level you choose will diversify between these two asset classes respectively.

However, we also seek to offset volatility by diversifying within each asset class. For example, we hold stocks in the tech sector via the NASDAQ index in the US, but we also hold stocks in the UK’s FTSE 100 and European equities less concentrated in the technology sector. If the tech sector experiences a period of high volatility, Nutmeg portfolios will still hold equites in other sectors such as manufacturing or healthcare that may be less volatile. This aim for balance is also replicated by region: if emerging markets experience volatility, we also hold equities in developed market indices which may be more stable. Likewise, assets such as bonds and gold which we also hold, are good hedges against volatility in equities.

Below you can see how the diversification breakdown of the different asset classes in our fully managed risk level three and fully managed risk level eight portfolios (allocations correct as at 1/7/21 but are subject to change):

 

Risk level 3:

 

Risk level 8:

Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.

 

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The Nutmeg team
This was a team effort from Nutmeg.

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