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Investment Diversification |
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Investment diversification
11 February 2011
jeannette Showalter, CFA
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 The good news is that most investors understand that one way of reducing investment risk is through diversification of investment assets. More specifically, the goal is to own a combination of assets that are expected to appreciate or maintain value yet are not expected to have similar price movement, or in math terms, not positively correlated. The desired outcome: reduced risk yet increased returns.
A proactive investor might ask their investment adviser: “Am I diversified?” Along the way in their investment journey, they might not have gotten the right answer to that important question.
Diversification is a relative measure. If you started with one stock and broadened your portfolio to 10 stocks across a variety of industries, you are relatively more diversified than your starting point. If you had a portfolio that had only U.S. equities and you expanded your holdings to include foreign equities and a wide array of bonds, then clearly you are more diversified.
CME GROUP What is a typical mix of holdings? Credit Suisse Asset Management found that the typical exposure of the S&P Defined Benefit Pension Fund was 62 percent stocks; 29 percent bonds and 9 percent other investments (“Alpha Management: Revolution or Crisis” November 2005).
The fact that your portfolio might be similar in mix to an institutional portfolio doesn’t mean that the mix is right. The fact that the traditional investment adviser might be offering you the maximum in diversification strategies of which they know, are trained and/or are licensed to sell does not mean you are diversified. The adviser’s very best and well-intentioned diversifying strategies might not get you where you really need to be… especially in a bear market as we had in 2008-2009.
Prior to 2008, many an investor thought that some “stuff” in their “diversified” portfolio would go down in a correction but other “stuff” would go up or be unchanged. They couldn’t imagine that all would decline.
Investors found out in 2008-2009 that as their “diversified” U.S. stock portfolio was crashing, so were foreign stocks; they found out that as stocks were crashing all over the world, so were “diversified” portfolios of U.S. and foreign corporate bonds.
“Pray tell,” what asset class if added to a portfolio has the potential to solve this diversification dilemma? What asset class has generated a positive return in excess of U.S. equities over the past 30 years, trades across a wide range of global markets and has virtually no long-term correlation to most traditional asset classes (stocks and bonds)? What asset class was the only one to appreciate in 2008?
The answer is managed futures. Yes, the transparent and highly liquid, yet much maligned and misunderstood (though increasingly less so), asset class of managed futures (agricultural, energy and metal commodities futures, interest rate futures, currency futures, etc.).
Managed futures have the added benefit of being uncorrelated to the U.S. equity and bond markets. The 1983 seminal study by Dr. John Lintner, a Harvard professor, titled “The Potential Role of Managed Commodity-Financial Futures Accounts in Portfolios of Stocks and Bonds” was recently updated and confirmed by the CME Group (which includes the CME, CBOT, NYMEX and COMEX).
Dr. Lintner found that inclusion of managed futures in portfolios decreased risk. Managed futures can be owned by many a retirement plan- individual IRAs, pension plans and some 401(k)s, as certain 401(k) plans allow individual selection of an outside broker/administrator. The CME also felt that the diversification benefits applied to any institutional portfolio. “The results are so compelling that the board of any institution, along with the portfolio manager, should be forced to articulate in writing their justification in not having a substantial allocation to the liquid alpha space of managed futures.” (“Lintner Revisited: The Benefits of Managed Futures 25 Years Later” by CME Group and AlphaMetrix Alternative Investment Advisors LLC, 2010.)
So, before you dismiss as elusive the goal of portfolio diversification, consider how the alternative asset class of managed futures can positively impact your portfolio. Managed futures should not be confused with ETFs or long-only commodity funds which might not perform well in times of economic crisis.
In addition to talking to your investment adviser about additional diversification strategies and suitability, it might be wise to talk to a professional trained and licensed in commodities who is able to sell a product that might help you in your diversification goals.
— Jeannette Rohn Showalter is a Southwest Florida- based chartered financial analyst, considered to be the highest designation for investment professionals. She can be reached at
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An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
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