Diversification is dead – long live diversification

I recently wrote a two-part wire about how many portfolios that I see (and likely just many portfolios, whether I see them or not), aren’t even remotely well diversified, even though those investors think they’re diversified. See here:

Asset Allocation

Your portfolio may not be as well diversified as you think – Part 1/2

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Asset Allocation

Your portfolio may not be as well diversified as you think – Part 2/2

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Today, let’s take a slightly different angle on a similar topic.

To own a global, all-asset portfolio has historically been a path to solid returns. It’s a “portfolio”, to the extent you’re able to invest in that so-called portfolio, that has been hard to beat on a risk-adjusted basis, and it is typically made up of global equities, global bonds, global infrastructure, and global real estate. It’s about half at-risk and half defensive, about half US and about half non-US.

But for the last decade-plus, being diversified has hurt you. A lot.

You’re still up in a global all-asset portfolio, don’t get me wrong, but you’re up half of what someone exposed into the big US tech thesis is up. And over a long time – depending on how you exactly construct it, that global portfolio is down 12 of the last 15 years versus the mega-cap US stock market.

In round numbers, the S&P 500 is a 10-bagger since the bottom of the GFC market. The Nasdaq 100 is up almost 15 times. That’s about 10% annually on the S&P 500 and about 12% on the Nasdaq 100. Round numbers.

The global portfolio is up about 7%. Big differences, especially over that length of time.

There have been 4 times in capital markets history when concentration out-performed diversification for extended periods. We’re in one of them right now post-COVID, and the other 3 are so well known that they have their own nicknames:

• The Roaring Twenties,
• The Nifty Fifty, and
• The Tech Bubble.

The problem is, all 3 were followed by a crash – the Great Depression, the crash of the 1970s into the early 1980s, and one of the worst periods for US stocks that ran from the aforementioned tech crash through to the GFC.

It may not feel like it right now, but it turns out that US stocks do lag for periods. There’s the 3 mentioned above and another notable period was the 1980s when Japanese stocks ruled the roost and US stocks performed relatively poorly.

I’m a US market bull, and anyone who knows me or who reads my thoughts knows this already. I still assert that your best bet for growth right now lies in focusing on US equities. If you want income, stay in Australia but for the short-to-medium term at least, there is no other readily accessible market that will likely grow the way the US has proven it can do.

But that doesn’t mean go all-in.

You can if you’re gun-ho about growth, and you can if you have a very high tolerance for volatility, and you can if you have a lot of time on your side. But if you’re like most investors, you need to construct a tailored portfolio that is made up of a long-term core piece, a short-to-medium term tactical piece, and then a long-term and uncorrelated opportunistic piece. When you’re doing that, you need access to all kinds of asset classes, not just US stocks. You will need cash, investment grade fixed income, high yield bonds, private debt, private equity, public equity, and also alternative or opportunistic asset classes like venture capital, and event-driven strategies, amongst others.

Or you need at least some combination of those asset classes. It can be complicated, but the rewards of getting it right can be extraordinary.

Try to get it right.

Good luck out there.