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

One of the key tenants of investment management is to be diversified across various assets and asset classes. I actually prefer the adage that well-constructed portfolios are comprised of assets, asset classes, and even sub-asset classes, that go up over time, just not always at the same time. Subtle but important difference, I think.

Diversification is even the subject of a goofy little segment on CNBC called “Am I Diversified?” from one of America’s highest profile (but poorest performing) TV investors, Jim Cramer.

But are you diversified? Probably not and I’ll use the example of a client who, before I got involved, held the following securities (and percentage of the total portfolio):

So that’s:

Biotechnology   7%

Mining/Energy   47%

Financials   18%

Growth   19%

Telecommunications   7%

Consumer   2%

I ask, do you think that’s diversified? Yeah, me neither. At least 90% of this portfolio is entirely listed in Australia too, around 2% of the global market cap.

This is what I want this two-part wire to make you consider - are you loading up on mining and financials, and loading up on Australia? There’s a really good chance you are and that’s not ideal. But the good news is that it’s pretty easy to fix it.

First though, you need a portfolio philosophy. What’s yours? Oh, you don’t have one I hear. More good news, I’ll give you one.

Core - - Tactical - - Opportunistic

Your portfolio should have three overriding parts to it. The first is the core piece that should deliver solid outcomes over market cycles without needing to try to time markets. This is a piece every portfolio should have, it is long-term in outlook, it is fully diversified, and it reflects your broad investment goals. If you want growth, it should be dominated by growth. If you need income, it should be dominated by income. Remember that core means core for you.

The second piece is the tactical piece, designed to take advantage of market opportunities with attractive risk-reward dynamics, but also to reduce exposure to heightened risks. This is a piece most portfolios should have, it is medium term in outlook, but it includes some short-term elements. It should compliment your core piece so that if income gets cheap and your core is focused on income, go buy more income. Same if your focus is growth.

The last piece is the opportunistic piece, often trading time and liquidity for more attractive risk-adjusted returns in the future. This is a piece not every portfolio has, it is long-term in outlook, it has a low correlation to the core piece, and it is often (at least partially) illiquid.

Now the tricky bit…..how do I turn this into a real life portfolio? Grab your statement, and let’s do it together - I’ll follow up with Part 2 shortly.

Good luck out there.