Diversification Sucks

With US Stocks pushing up to new all time highs once again this week, we’re seeing more talk of going with simple over complex, just doing the basic 60/40 portfolio, and so forth. We’re seeing more of the feeling – “Diversification Sucks!  I would be waaaaaaaay better if was just 100% long US Stocks… or even better, 150% or 250% long.”

We had some clever things to say on this topic, but found the following post out there by James Osborne of Bason Asset Management (from a few months ago) which said it much better:

DIVERSIFICATION SUCKS

Let’s face it.  Being a diversified investor is terrible.

1) You will always be worse than the best performing asset class (and you will always compare your performance to the best asset class, because your brain is terribly designed for investing). For this reason your portfolio’s performance will always seem mediocre.

2) You will always be worse than the current “darling” stock of the street.  Maybe it’s Netflix or Tesla. Or rewind 15 years and it’s Amazon and Cisco. Doesn’t matter. You’ll wish you had some of that, and ignore the fact that you also avoided owning things like GT Advanced Technologies, Apple’s glass screen supply partner who just filed for bankruptcy.

3) You will always hate something in your portfolio.  Really, really hate it.  Emerging markets have been a drag on a diversified portfolio for years now. Who is happy that they have owned emerging markets for the last five years? Who is happy they owned REITs in 2013? Who is happy with short term bonds for the past several years? No one.

4) You will never have enough of the good stuff.  US large cap stocks are the place to be? Tech is shooting up? Long-term bonds keep doing well? Why didn’t you own more of that?

5) That part of your portfolio that you love will turn on you in a flash.  You’ll hate it, and you won’t ever remember loving it. International stocks led the charge for years leading up to the financial crisis, and have since been lackluster. We are fickle and almost never satisfied.  We expect good performance and we don’t want to be around for the bad times, as if we can predict or control what happens in the markets.

For these reasons, you will always want to tinkerYou will always think your allocation is wrong (guess what: it is!). You will always feel the pull to chase performance because clearly your strategy is “not working.”

I honestly believe that next to a huge bear market, our current market may be the hardest for a diversified investor to stomach.  The only thing that seems to be “working” is having more exposure to large cap US stocks.  Practically everything else is a drag on performance. And many investors myopically focus on large cap US stocks, via the DJIA or the S&P 500, as “the market.” So as soon as you deviate from the S&P 500 in your portfolio; when you add in international stocks or small cap stocks or REITs or emerging markets, you start to “lose.”

This is why investing is not easy; why successful investors know they have to remain focused on the long term. Owning a diversified portfolio of index funds sounds simple enough, but we are so prone to get in our own way. Hear this: the single worst thing you can do for yourself in an environment like this is to start making changes to your investment policy. (By the way, if you change your investment policy based on market performance, you don’t actually have an investment policy). You don’t need to have the “right” asset allocation (such a thing does not exist), you need to KEEP THE ONE YOU HAVE. If you have thoughtfully constructed a diversified portfolio of investments, nothing is wrong with it. The only thing you can do to make things worse for yourself in the long run is to change your allocation in response to weak performance from certain assets. Don’t do it.

Couldn’t have said it much better ourselves. And here’s the crazy thing, we’re saying it when our preferred diversifier – managed futures – is doing quite well, thank you (up 15.67% last year and 2.10% through Feb 17th, according to the Newedge CTA Index) {past performance is not necessarily indicative of future results).  We’re saying it because we know trees don’t grow to the sky (despite the 2009-present evidence to the contrary in US Stocks). We’re saying it because stocks are due for a pull back. Bonds are due for just had a pull back. And yes, even Managed Futures are due for a pull back, especially the bond heavy systematic guys (they’re pulling back already in Fed thanks to that bond market reversal).

So enjoy it while it lasts, and curse your diversification strategy as ‘sucky’, but just make sure it’s complaining only, and not action following the complaining. Because that’s when your sucky diversification actually becomes bad, that’s when you’ll turn off your protection just before it’s needed most.

Here’s a linkfest to Value Investing, Diversification and the grand ol’ Stock vs. Managed Futures debate.

1. Sell Everything and Buy Stocks
2. Sell Everything and Buy Stocks 2
3. Why Am I Diversifying Again?
4. Why Value Investing is So Hard (Managed Futures Style)
5. Even Bad Diversification Works
6. Pursuing Portfolio Perfection
7. Rethinking the Efficient Frontier
8. The Efficient Frontier
9. The Efficient Frontier Part 2
10.  Did He Just Say Diversification Was Broken?
11. Diversification: Giving up Home Runs, to Avoid Futures Strikeouts
12. Would’a Could’a Should’a
13. Do Investors Really Have To Choose Between Rotten Eggs?
14. Same Shift, Different Color: Traditional 401(k) “Diversification”
15. 5 Questions Every Investor Needs to Answer

 

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.