Money Talks: A case for diversification
As investors here in paradise continue to be both baffled and at the same time mesmerized by the movement and direction of the stock and financial markets, many have embraced the reality that at some point in time, there must be a day of reckoning. Certainly this “day of reckoning” should be expected as the normal course of stock investing; it is a given and is understood before entering the arena.
For the vast majority of retired investors, the idea of investing has fallen into a single, simple category consisting of mainly stocks and mutual funds. There are investors who actually own individual bonds for any number of reasons, yet the majority simply sit idle with the same assets they have owned for most of their investing lives; stocks. Certainly there is nothing wrong with this scenario as long as there is some type of rationale such as knowing both what they own, and perhaps more importantly, why they own it.
In its simplest form, the concept of investing is centered around the ability of a portfolio to build, preserve and protect the nest egg. Most will agree this is a basic and digestible objective over the long term. Many attempt to achieve “diversification” in order to smooth out the ride as well as allow the portfolio to grow in any economy environment. Thus the basis of owning multiple “styles” of stock while at the same time embracing the addition of bonds to the portfolio with the simple idea of bonds offering a perceived level of safety as well as an opportunity to thrive when stocks struggle. This is indeed the “old school” style of portfolio management.
Perhaps the greatest and misunderstood investing myth is the simple idea that different types of stocks offer “diversification”. Many retired investors own growth stocks, income stocks, large cap stocks and small cap stocks, etc. While this seems diversified, the reality is that simply giving stocks different names does not change the fact that they are still one asset class…stocks. While the addition of bonds also brings some level of diversification, the cold reality of 2017 is that both stocks and bonds have had incredible runs and yet at the same time both are equally poised to lose value, unfortunately, at the same time. So much for diversification.
Research with proven results reveals a strong case for “true diversification” with the addition of an alternative asset class capable of generating returns in all economic conditions, regardless of how stocks and bonds may be performing, or in this case eventually underperforming. Retired investors who embrace the ability to “weather the storm” have slowly begun to embrace the alternative asset class concept in part as a result of the Nobel Prize winning research known as “Modern Portfolio Theory”, or MPT. MPT capitalizes on the concept of “efficient frontier” whereby this research established that the “sweet spot” maximum return with minimum risk lies within the combination of asset diversification. In other words, the addition of an alternative asset class, in addition to stocks, has proven to offer the true efficient frontier for performance.
MPT makes a clear, definitive and undisputed case for the addition of Managed Futures. Their ability to increase returns while reducing risk in the overall portfolio has created a compelling case for true diversification. In fact, research generated by Barclay and the CME Group points out 10 compelling reasons to add managed futures to one’s portfolio. Let’s review ...
- Diversification beyond traditional asset classes.
- Reduce overall portfolio volatility.
- Increase overall returns.
- Returns evident in any type of economic environment.
- Strong performance during stock market declines.
- Successful institutions use them.
- Total transparency.
- 100 percent liquidity.
- Tax advantage treatment of gains.
- Managed Futures are closely regulated.
While the definitions go into greater detail, the basis here is that the ability for futures to maintain a near zero correlation with stocks perhaps makes them an ideal addition to any portfolio for suitable investors. The Nobel Prize winning proven track record of increasing returns while reducing risk certainly makes a case for diversification, or in this case “true” diversification, leading investors towards the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.