Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

There’s a good reason why we talk about diversification here at Fidelity. It’s an admission of our limits. Not even our sharpest investors know exactly what’s going to happen across markets tomorrow. We make informed predictions, but markets possess an unrivalled capacity to surprise.

Diversification is the best tool investors possess to protect against those surprises. By spreading your money across different kinds of investment, you give your portfolio the best chance to keep firing even if some of its cylinders are running on empty.

But how exactly do you do that?

There are a few ways investors can diversify. One is across asset classes. Different assets such as equities and bonds typically perform differently. This means that what hurts the bond market won’t (usually) hurt equities, and vice versa.

The second is geographies. Different markets are shaped by different influences. A dent in the US market won’t necessarily be felt in, for instance, Japan. Your holdings in the latter will often be unaffected by what happens to the former.

A less obvious way is across styles. “Style” refers to the investment philosophy or approach which different funds and companies adopt to achieve their aims.

Diversifying your portfolio across different styles can be just as influential on performance as different asset classes and geographies. So, how does it work?

Growth vs value

When investors talk about different styles, they’ll usually break them down into two: growth and value.

Growth investors favour companies whose earnings look set to grow and grow long into the future. They’re often companies that look to shake up an industry or can keep the competition at arm’s length through some competitive advantage (or “moat”). These characteristics mean they’re usually seen as ‘defensive’ stocks that prove resilient through market downturns. For similar reasons, investors may be willing to pay high prices to hold them. Last year’s pandemic winners, the Big Tech and Pharma companies, are good examples.

Value investors, by contrast, look for companies they feel are trading at a discount to their true worth. These may be ‘cyclical’ companies that struggle when the overall health of the economy is weak (e.g. airlines or financials), whose real value is yet to be recognised by the wider market, or which are temporarily experiencing some adversity that has left them them unpopular.

Each style tends to perform differently through market cycles. The Coronavirus pandemic laid bare some of these differences.

In March, when the virus ran rife and markets collapsed, investors flocked to the same high growth names like Facebook and Amazon. Investors were more than happy to pay up for their defensive characteristics.

Since positive vaccine news first emerged in November, however, the pendulum has swung the other way. Now investors are turning to value stocks, which look set to benefit from reopening economies and consumer purses bursting at the seams. Recent expectations for inflation and higher interest rates have also hurt growth names, making value attractive by comparison.

The last 12 months tell us a lot about the power of diversifying by style. To start, no one knew what was going to happen this time last year. You may now rue not putting all your money into growth names, but investing is much easier in retrospect.

In order to benefit, you would have had to nail the timing in March as well as the subsequent transition from growth to value - a nigh on impossible skill to master. No one rings a bell at the top or bottom of market cycles.

If you’d have diversified across the styles, you would have been well exposed to both stories. Yes, your value names would have suffered for the first six months, but your exposure to growth would have counterbalanced their losses before value began to repay your faith in November.

The wisdom of the approach isn’t limited to 2020.

Growth has certainly been in the ascendency in recent years: any value invested in the growth index 25 years ago would have returned more than double the same amount invested in the value index.

But looking over a much longer period, value has significantly outperformed. Such has been value’s outperformance that, until recently, it was widely assumed that value investing was the best approach for long term investors.

There have even been periods in the last 25 years of clear value outperformance. From the bursting of the bubble in 2000 to the aftermath of the financial crisis in 2009, value was the place to be; since then it’s all been about growth.

Style, then, can have a huge bearing on returns. None of us has a crystal ball, making it impossible to know which style will do best in the future. Much safer (and far less stressful) to cover all bases.

In practice

When compiling our Select 50 list of favourite investments, our analysts will cover most styles through their selection of funds in any given geography or asset class. As with any well-diversified portfolio of holdings, not every fund on the Select 50 will always outperform. Held in tandem, however, their complimentary characteristics should deliver positive returns over the long term and through market cycles.

A case in point is the Fidelity UK Select and Fidelity Special Situation funds. Both are UK equity funds: judging by both asset class and geography, they offer little diversification. Compare them by style, however, and they’re two very different beasts. The former has a growth bias, the latter a value.

When selecting his fund picks for 2021, my colleague Tom Stevenson knew he wanted some exposure to UK equities because he thought the prospects for our home market’s vaccine-fuelled recovery looked promising.

However, he was unsure which style would do best. That’s why he decided to hold exposure to both - that way, he’s diversified across both a growth and value-led recovery.

Tom recently met with Aruna Karunathilake, manager of the Fidelity UK Select Fund, and Alex Wright, manager of the Fidelity Special Situations Fund. You can watch those interviews below.

Fidelity UK Select Fund

Fidelity Special Situations Fund

Important information

Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. The Fidelity UK Select Fund invests in a relatively small number of companies, so may carry more risk than funds that are more diversified. Fidelity Special Situations Fund and Fidelity UK Select Fund may invest in overseas markets, so the value of investments could be affected by changes in currency exchange rates. The funds use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The funds may also use currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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