Why portfolio diversification is now more important than ever

Spreading risks means investors have the resilience to recover when some sectors underperform

The primary goal of portfolio diversification is to reduce the risk of your investments, especially during market crashes. Photo: Getty Images

The global economy has been severely impacted by the Covid-19 outbreak. The pandemic was an unanticipated occurrence that temporarily resulted in a sharp drop in asset prices. Investors should aim to maintain a well-diversified investment portfolio in order to survive such market shocks.

The primary goal of portfolio diversification is to reduce the risk of your investments. A well-diversified portfolio across different sectors provides your investments with the resilience required to recover from drawdowns when some sectors underperform and others outperform.

Different asset classes and sectors will perform differently over time, whether in times of crisis or economic growth. As a result, a multi-asset investment portfolio should perform well in the long run.

The main objective when constructing your portfolio is to achieve a suitable balance of investments, which can be accomplished by having an appropriate mix of low-risk and growth investments that are aligned with your risk tolerance.

Investment managers must understand clients’ needs and requirements to define their objectives and long-term financial aspirations that are in line with individual circumstances, including risk appetite, life cycle and time horizon.

In addition, people should not underestimate the effect of inflation on the purchasing power of wealth. Therefore, having investments that can appreciate over time is necessary to reduce the impact of inflation.

As a result of the pandemic, for example, the technology and healthcare sectors performed exceptionally well in 2020, while airlines and tourism-related industries suffered. In terms of asset classes, low interest rates and investors’ “flight to safety” resulted in strong gains in investment-grade government bonds, which are viewed as a safe haven during times of crisis.

However, investment decisions should not be based solely on a reaction to a recent event but rather on long-term objectives that adhere to diversification principles.

Regardless of the stage of the economic cycle, we continue to believe that maintaining a well-diversified portfolio is the way to go.

However, one should be aware of how long-term structural trends are shaping up, such as digitalisation, as well as the winners and losers from such trends, and then adjust sector allocation accordingly.

When it comes to digitalisation, we can’t help but notice this as a post-Covid-19 trend. We are currently witnessing a significant shift towards digital technology.

During movement restrictions imposed to limit the spread of Covid-19, technology demonstrated remarkable resilience in ensuring that many aspects of the economy continued to function. Many institutions prioritised their digitalisation initiatives, which led to more investments into this space.

As a result of the Covid-19 vaccine rollout and the opening of some countries, we are witnessing some economies recovering faster from the pandemic and others lagging behind.

Investors should start thinking of countries that started to outperform when allocating their investments, in addition to making sure they have a well-diversified portfolio across different sectors considering inflation and digitalisation.

Haitham Abdulla is an investment solutions manager at the National Bank of Fujairah.