Neil Woodford's recent performance highlights the importance of diversification

There's no denying the fact that Neil Woodford's performance over the last year has been poor. For 2017, his Equity Income fund returned just 0.8%, significantly underperforming the FTSE All Share index's return of 13.8%. Investors would have been better off holding cash.

Understandably, many are unhappy. His performance in 2016 was poor as well, with the fund returning 3.2% vs the index's 16.8%. At a time when making money in the stock market has been relatively easy, the UK's most celebrated portfolio manager has bombed out big time.

This underperformance highlights the fact that even the best money managers experience challenging periods. Woodford has an excellent long-term track record, but in the last few years, he has dramatically underperformed his peers.

So what's the lesson here?

Diversify your funds

To my mind, this highlights the importance of diversification. It's a topic I've been banging on about quite a bit recently.

The bottom line is that diversification is an extremely important wealth management concept. Yet many investors fail to do it properly. They don't have a thorough understanding of what it means to be diversified.

It means more than just buying a handful of stocks. It means buying stocks in different sectors, across different geographical regions and of different market capitalisations. Importantly, if you invest in funds, it means spreading your capital out across several different funds too.

I've got no doubt there are plenty of investors who backed Woodford with all their capital, believing they were fully diversified. After all, the portfolio holds over 120 stocks. They'll be frustrated right now, after a 4% return in two years.

A better strategy would have been to back several different fund managers. This way, the risk of one portfolio manager underperforming is dramatically reduced.

Safety in numbers?

Looking at my own SIPP, I currently hold four funds. These include the Lindsell Train Global Equity fund, the Threadneedle European Select fund, the Rathbone Income fund, and Woodford's Equity Income fund.

As a result, while Woodford's recent underperformance was frustrating, my portfolio still did pretty well over the last 12 months. Nick Train's global fund returned 26.1% for the year - an excellent performance. Similarly, the Threadneedle European fund returned 19.6% last year - another strong return. The Rathbone Income fund's return was a little weaker at 8.5% for the year, but given that it has generated a return of 29.3% over three years, I'm not too concerned. Diversifying across several funds ensured that I didn't suffer too much from Woodford's poor performance.

Could I diversify further? Absolutely. As my SIPP grows, I'll be looking to diversify my global equity and European funds across several different portfolio managers. I'm also keen to add some small-cap funds and diversify my geographic exposure, by adding some emerging markets funds. When it comes to long-term investing success, diversification is a fundamental concept that shouldn't be ignored.

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