Head of FE Research Rob Gleeson on how diversification has been the key to FE Invest portfolios' success at a time when sector peers have failed to shelter from the market turmoil...

The large market correction triggered by further evidence of China losing its puff has been brutal. Most markets suffered severe losses in a single day, and while the worst of “Black Monday” was erased as markets recovered, volatility remains high and most asset classes are still posting losses. It is curious then that in this context the FE Invest portfolios have had one of their most successful runs.

The FE Invest suit of portfolios, which target different risk levels and time horizons, have out-performed their equivalent IA mixed sectors. While it is worth pointing out that as discretionary model portfolios they don’t belong in these sectors; their risk targeted multi asset strategies make for good comparison with the funds in these sectors, which are probably our most natural peer group.

The cause of this performance hasn’t been because we saw the crash coming, or because we’ve been able to pick the best funds or spot undervalued markets. It has been because we’ve accepted the universal truth; we have no idea what’s going to happen. While there is a mountain of market analysis looking at valuations and economic indicators, all predictions can be boiled down to three categories. Markets will go up; markets will go down; or everything will stay the same.

We think all three things are likely to happen at some point, but we don’t know when or in what order. Once you’ve accepted this you can go about building a portfolio that cover all bases. That is what our diversification targeted approach is designed to do. Every decision we make isn’t based on our view of the market, but on the diversification benefit to the portfolio.

Ironically, it is by accepting that we can’t beat the market that we make most out of active management. By selecting fund managers whose strategies are built around these three scenarios and blending them together, we are covered no matter what, rather than just tracking the market down. We maximise the diversification benefit from active strategies to manage risk, rather than relying on alpha for performance.

That’s not to say economic analysis doesn’t form part of our process, but it is limited to planning for scenarios and making sure there are strategies in the portfolios that have them covered. This way when the worst happens, there is always something in the portfolio that was set up to profit. This time round our allocation to gilt funds was that something.

It has been common knowledge that gilts are in a bubble ready to burst any day now for at least three years. We ignored the market sages on government bonds and stuck with them because in our view, there was also a scenario where they went up and one where they stayed the same, and we wanted to be prepared should those scenarios come to be.

While as investors market falls are never welcome, it’s been great to see our approach vindicated and prove the value of diversification.