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Diversification of Investment Portfolios

The following article is for professional advisers only and is not intended to be shown to retail investors.

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“Never put all your eggs in one basket” is sound advice in the investment field as it is in any other. Diversification of an investment portfolio, of course, means holding a variety of different asset classes, and across different sub-sectors and geographic locations.

Diversification is important as different types of assets behave in different ways depending on the economic factors driving them. Sentiment of investors can also play a significant part in short-term performance of different assets. As values of different asset classes tend not to head in the same direction at the same time, diversification can enhance the volatility/return profile of an investment portfolio. The chart below shows how different fund sectors have performed by looking back at the annual return every month for the past ten years.


As you would expect, of the ‘traditional’ asset classes, equities tend to be the most volatile but offer the potential for high returns. Cash is the most stable asset class but offers little prospect for investment return, often providing negative returns in ‘real’ terms after allowing for the effects of inflation. Others such as fixed income and commercial property tend to sit somewhere between them.
Portfolio construction
It has always been common practice to hold a blend of these traditional asset classes in a portfolio, weighting more into equities for the more adventurous investors or those with long-term investment horizons. Conversely, those with lower appetites for risk or with short-term investment needs, usually weight their portfolios more heavily to cash and fixed income.

However, one asset class which has previously been missing from investment portfolios is residential property – despite its track record of providing strong yet relatively stable investment returns, and the fact it has little correlation with the traditional asset classes. Despite a large number of private landlords investing directly into buy-to-let properties, the options have been very limited for those who want a more diverse portfolio or hold their investments on fund platforms and in ISAs or SIPPS. The next chart shows the frequency and range of distributions for the same IA sectors as the chart above, but also includes the well-known Halifax House Price Index to represent residential property as an asset class.

An increasing number of fund managers are now moving into the residential property sector. Whilst most of these are focussed on institutional investors such as public and private sector pension schemes, one fund (the TM Hearthstone UK Residential Property Fund) permits investment from anyone. Launched mid-2012 it invests in a diverse portfolio of flats and houses across the UK and can be held in all the popular tax wrappers such as SIPP, ISA and offshore bond.

This fund has an obvious attraction as an alternative to buy to let investment or to gain an investment link to house prices, but it can also play a part in diversifying an existing portfolio. Over the past three years the fund has shown its returns have low or slight negative correlation with funds invested in traditional asset classes, including those which invest in commercial property.


Source: FE Analytics, 3 years to 31/01/2017, Bid-bid with income reinvested.

Furthermore, when returns and volatility are plotted against these same IA sectors and the Halifax HPI, the TM Hearthstone UK Residential Property Fund has generated above average returns with below average volatility.

These characteristics would make the fund a candidate for inclusion in any portfolio where the objective is to reduce volatility and enhance total returns.

My clients own a family home
Despite the fund’s returns profile, portfolio managers may consider overlooking the asset class as many of their investors have some exposure to residential property in the family home. However, that family home was most likely a lifestyle purchase rather than an investment decision. It’s unlikely the portfolio manager would advise a client to sell the family home and move into rented accommodation if he or she felt the outlook for the housing market was negative.

If that’s not a sufficiently convincing argument, let us consider a similar situation where a client runs their own Limited company and has a large amount of wealth in that business as a majority shareholder. By the same reasoning, that client should not invest in a UK equity fund as he or she already has exposure to the sector. That, of course, is ridiculous: the UK equity market has a vast array of sectors and companies for funds to invest in and UK equity funds provide a way to gain diversified exposure to the sector. The same is true of the UK housing market – many different property types, towns and cities with different demographics, and potential tenants who could be individuals, couples or families. A residential property fund can give an investor exposure to a professionally managed portfolio of properties across all of these different markets.

Regardless of whether clients are home owners, their investment portfolios can benefit from some exposure to a residential property fund. The fundamental characteristics of low correlation, above average return and below average volatility when compared to other asset classes can enhance the risk/reward profile of their overall portfolio.
Furthermore, residential property funds can be held in pensions, ISAs and offshore bonds just like any other fund, so the potential benefits are available to all investors.

This article is aimed at investment professionals and is not intended to be shown to retail clients. This document is not in itself a prospectus, invitation to invest or advice.

Where estimated or projected figures are used these are clearly stated. Hearthstone or Thesis Unit Trust Management cannot be held responsible for investment decisions made on the basis of those estimates.

Investors may get back less than the amount invested. Information on past performance is not necessarily a guide to future performance. The value of investments in the fund can go down, and there can be no assurance that any appreciation in the value of investments will occur.

Residential property values are affected by factors such as interest rates, economic growth, fluctuations in property yields and tenant default. Property investments are relatively illiquid compared to bonds and equities, and can take a significant amount of time to trade.

The Authorised Corporate Director of the TM Hearthstone UK Residential Property Fund is Thesis Unit Trust Management Limited, Exchange Building, St John’s Street, Chichester, West Sussex, PO19 1UP.   Authorised and regulated by the Financial Conduct Authority.

Copyright Hearthstone Investments PLC 2017.  Hearthstone Investments PLC is the parent company of the Hearthstone Investments Group. Regulated business is carried out by Hearthstone Asset Management Limited. Hearthstone Asset Management Limited is an appointed representative of Thesis Asset Management PLC which is Authorised and regulated by the Financial Conduct Authority (114354).

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