Managing an investment portfolio isn’t just about selecting securities that have the best chance of achieving a stated return. It is also about managing risk, and this has literally been one of the primary functions of portfolio managers for thousands of years. Ecclesiastes 11:2 says, “Divide your portion among seven or even eight investments, for you do not know what calamity may happen on earth.”
I tell my clients that one of the best ways to manage portfolio risk is to apply the age-old wisdom of diversification. But what exactly is diversification? Is it just a collection of different stocks from different countries and sectors?
At Capstone, we believe that adding more into a portfolio than just traditional stocks and bonds provides our clients with real diversification. This means that incorporating non-traditional investments (or “alternatives”) – such as real estate, private equity, private debt, infrastructure, etc. – will achieve greater security. Diversification from our perspective is a collection of uncorrelated investments, that will behave independently from each other when various market events occur.
Why doesn’t a broad selection of traditional stocks or bonds provide real diversification? The biggest reason is that during periods of extreme economic stress and volatility, market traded securities (traditional stocks and bonds) begin to move together (usually down) as investors flee from these markets. This can be observed specifically during the 2008 debt crisis. Conversely, those who have incorporated non-traditional investments have experienced better stability in returns over the long run.
By creating a well-diversified portfolio today, you can decrease your potential exposure to risk in the event of a future market crisis.
Maria Dawes, Portfolio Manager
Capstone Private Wealth