Rethinking Asset Allocation and Diversification

In a recent interaction, Morningstar Investment Management CIO Dan Kemp, addressed the question as to whether diversification still works. Here's what he had to say:

"The year 2022 was a real surprise. There were big global macroeconomic shocks like the war in Ukraine, we had share prices falling and bond prices fell as well. People typically rely on the price movements of bonds to offset that of shares because they normally move in opposite directions. And so, if you hold both shares and bonds in your portfolio, then one is designed to offset the other, and that may give you a smoother ride as an investor. That does usually happen, but it did not happen in 2022.

"There have been times in the past where we a synchronized downturn in equities and bonds: 2013 (taper tantrum), 1994, and early 70s. The fact that we can highlight those three areas in the last 50 years is a real reminder that normally bonds do their job. And there's no reason to expect that bonds won't do their job in the future."

What no one tells you about DIVERSIFICATION

Diversification is not just an academic nicety but a core tenet of investing. It is also completely misunderstood. Most believe that diversification is about holding different investments in a portfolio. Well, you start with that, but it doesn’t end there.

Howard Marks describes it more aptly. “Intelligent diversification means not just investing in a bunch of different things, but in things that respond differently to the same factors. In a well-diversified portfolio, something that negatively influences investment A might have a positive and offsetting influence on investment B.”

This variability in response not only benefits the portfolio, but also the investor.

5 ways to view ASSET ALLOCATION differently

What comes to mind when you hear the words asset allocation? Equity, debt, cash, gold and real estate. Probably art and commodities, if you are so inclined.

But there is much more to it. The money that we have is limited. Our time on this planet is limited. Our energy is limited. And how we efficiently allocate accordingly matters a great deal.