An illustration of the need to diversify

Schroders produces a wall poster each year that shows the relative performance of all asset classes from the past 20 years. It’s one of the most popular items we provide to clients because it serves as a stark reminder of the role diversification plays in portfolio construction.

This year’s table is ever more striking, given it visualises the change in performance across the asset classes between 2017 and 2018, which are two of the most polar opposite side-by-side comparisons.

2017 was noted for its lack of volatility, evident in the strong performance of equity markets, so much so that for the first time global equities, based on the MSCI ACWI’s 30-year history, saw a rise in every month of the year. While the US market (S&P 500) did not post a rise it saw a positive return every month once dividends are included, for the first time since 1958. The largest fall for the US market intra-year 2017 was 3%, which is the smallest intra-year fall in any calendar year in the post war period.

In fixed income markets, bond yields finished 2017 at levels close to where they started. The lack of volatility over the year saw US 10-year yields posting their lowest annual trading range since the 1960s.

2017 was also the year of wild speculation, highlighted by the interest in crypto currencies, where bitcoin rose 1,300%, and in the art world, a world record $US450m was paid for Leonardo Da Vinci’s Salvator Mundi, shattering previous records.

The results table reflects this. Equities were the three highest returning asset classes that year, but things were about to change, and fast. 2018 was quite the opposite, with local and global equity markets posting negative returns. With regards to volatility, it was like chalk and cheese. Last year started and ended with bouts of volatility, while February offered investors a glimpse of what could happens as economic conditions and policy shifted, but the markets recovered.

By August the bull market became the longest on record – at nearly 3,500 days and counting. However, October is known for crashes and it didn’t disappoint, with sharp falls in equities and credit markets followed.

Though markets saw a bounce back by the end of the month, it became clear that growing fears around trade and uncertainty over Trump’s tariffs on China had started to flow through into market sentiment. The ‘Santa rally’ proved to be the opposite in December, as global equity markets fell sharply and credit spreads widened under the pressure of trade policy, and ended the year in the red.

Bonds did better in this environment of uncertainty and finished the year the best performing asset class. Proving active asset allocation can be beneficial during uncertain times.

The tale of two years – and the past two in particular – highlights how one year’s winner could be next year’s loser, and diversification is key to weathering all market environments.

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