Why Is Portfolio Diversification Important?

We choose to remain independent because we believe that it is important that we are not restricted in any way when we recommend a product or fund.


Our dynamic approach to managing our clients’ diverse portfolios is driven by our desire to provide comprehensive, coherent investment plans that remain flexible and adaptable. Circumstances change and our advice, backed by our state of the art systems and portfolio diversification, can respond quickly and effectively to meet those changes.

Our investment process is backed by portfolio diversification, meaning following changes in the stock market, investment diversification can provide a safety net to ensure that the value of a portfolio remains.

What is Portfolio Diversification?

Portfolio diversification is with regards to spreading your money across more than one investment. Investment diversification can balance the level of risk in your portfolio and this is something that can never be overlooked. Diversification allows an investor to reduce investment risks in addition to potentially improving investment returns.

Portfolio diversification is about utilising the benefits of multiple investment sectors, with the aim to reduce the volatility of your portfolio. When looking to create the ‘perfect investment’ the objective is to increase the potential for greater returns, whilst reducing the potential capital volatility. Investment diversification is one way to achieve this as well as provide peace of mind that your investments are equipped for changes in the market.

Diversified portfolios can look very different, and below is an example portfolio which contains the following investments:

  • Stocks – stocks are risky but if successful represent significant growth potential.
  • Bonds – bonds include treasury and corporate bonds, which offer reduced investment risk but lower potential growth.
  • Certificates of deposit – CDs and money market funds tend to have minimal risk but offer very small growth potential.

How KLO use Investment Diversification to Aid the Investment Process

We specialise in building risk-appropriate investment portfolios aided by investment diversification. By looking at your financial objectives and personal attitude to risk, we determine which portfolio is most appropriate for you.

A fund is only considered for our portfolios if it has satisfied our rigorous selection criteria. Our investment committee examines our portfolios every quarter, with input from our dedicated ‘in-house’ investment analyst. A full explanation of our selection criteria is offered below:

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Frequently Asked Questions

Alpha is a measure which shows the extra value that the manager’s activities have contributed to performance: if the Alpha is 5, the fund has outperformed its underlying benchmark by 5%, suggesting the manager’s activities have added to its value. The greater the Alpha, the greater the outperformance.

Beta is a statistical estimate of a fund’s volatility by comparison to that of its benchmark. A fund with a Beta close to 1 means that the fund will move generally in line with the benchmark. Higher than 1, and the fund is more volatile than the benchmark, so that with a Beta of 1.5, the fund will be expected to rise or fall 1.5 points for every 1 point of benchmark movement.

Standard deviation is a statistical measurement which, when applied to an investment fund, expresses its volatility, or risk. It shows how widely a range of returns varied from the fund’s average return over a particular period. Low volatility reduces the risk of buying into an investment in the upper range of its deviation cycle, then seeing its value head towards the lower extreme. For example, if a fund had an average return of 5%, and its volatility was 15, this would mean that the range of its returns over the period had swung between +20% and -10%. Another fund with the same average return and 5% volatility would return between 10% and nothing, but there would at least be no loss. While volatility is specific to a fund’s particular mix of investments, and comparison to other portfolios is difficult, clearly, for those that offer similar returns, the lower-volatility funds are preferable. There is no point in taking on higher risk than necessary in order to achieve the same reward.

In simple terms this ratio shows the amount of excess return generated per unit of risk. This is a commonly-used measure which calculates the level of a fund’s return over and above the return of a notional risk-free investment, such as cash or Government bonds. The difference in returns is then divided by the fund’s standard deviation – it’s volatility, or risk measurement. There is no absolute definition of a ‘good’ or ‘bad’ Sharpe ratio, beyond the thought that a fund with a negative Sharpe would have been better off investing in risk-free government securities. Clearly though the higher the Sharpe ratio the better: as the ratio increases, so does the risk-adjusted performance. In effect, when analysing similar investments, the one with the highest Sharpe has achieved more return while taking on no more risk than its fellows.

This is the total historic return of a fund over a 5-year period.

We take into account the average annual returns had the fund been held over 1, 3 and 5 years.

Ongoing Charges Figure (OCF) shows the drag on performance caused by operational expenses associated with a fund. Expenses which are represented by this figure include payments to the manager, the trustee the custodian and their representatives. The figure also includes registration, regulatory, audit and legal fees, and the costs of distribution.

Performance fees, transaction costs, interest on borrowing, costs associated with derivatives, entry and exit fees and soft commissions are not included in the OCF calculation, and should be factored in separately by the investor. The OCF is calculated by taking the sum of these expenses incurred in the last 12 months and dividing this by the average net assets of that class for the last 12 months.

FE Risk Scores define risk as a measure of volatility relative to the FTSE 100 index, which has a risk rating of 100, and rebased to sterling. Instruments more volatile than the FTSE 100 have a score above 100 and vice versa giving a reliable indication of relative risk. Most volatility measures are based on absolute risk. Because the absolute levels of risk in markets naturally ebb and flow, risk levels can appear to change without there being significant changes to the fundamentals. So these changes could spuriously encourage people to sell or acquire particular investments. Relative risk is not affected in the same way, and is likely to provide a clearer indicator of important risk changes. Scores are recalculated weekly on a rolling three-year total returns basis. Most funds would fall between one and 150 with direct equities scoring above 100 and pure cash = zero.

FE Crown Fund Ratings enable investors to distinguish between funds that are strongly outperforming their benchmark and those that are not. The top 10% of funds will be awarded five FE Crowns, the next 15% receiving four Crowns and each of the remaining three quartiles will be given three, two and one Crown(s) respectively. Rebalanced twice a year in January and August, the rating takes into account three key measurements to derive a fund’s performance: alpha, volatility and consistently strong performance.

This is based on rolling returns over 0-12 months, 12-24 months and so on. Not all of the funds in our fund universe will have shown any losses over a 3 or 5-year period, however where there have been losses we look at what these have been relative to other funds in the sector and how these losses look in relation to gains made over the same period.

The Morningstar Rating, most commonly referred to as the “star rating”, is a purely quantitative, backward-looking measure of past performance. It is based on a fund’s risk and cost-adjusted performance over 3, 5 and 10 year periods.

We look not only at the length of time a manager has been managing a fund, but also what his or her experience and background is over their career. FE Alpha Manager Ratings rate the performance of a fund manager over their career including all funds they have managed and places worked. They are designed to distinguish fund managers who have consistently performed well over the longer term based on two key components: Risk adjusted alpha (with track record bias) and consistent out-performance of a benchmark overall.

We then select the most appropriate funds for our clients depending on the nature of the portfolio we are building. This could be a portfolio that is growth or income orientated, or that has been ethically screened, but each portfolio will be designed to target set risk profile asset allocations, according to the level of risk appropriate for our clients.