Most Wealth Counsellors you speak with today, will tell you that you must diversify your investments to reduce the portfolio’s volatility. We concur with this statement. Portfolio diversification is an integral part of the portfolio management process. With that said, the question we must ask ourselves is whether it’s even possible to diversify one’s portfolio amongst traditional assets?
Prior to the turn of the decade, it was relatively easy to diversify ones portfolio by having a portfolio comprised of Canadian equities, U.S. equities, International equities and bonds. Up until about a decade ago, bonds tended to behave opposite to what stocks did, so adding them to a portfolio certainly added diversification benefits. Adding international equities to one’s portfolio also provided diversification benefits.
Unfortunately, that was the past. It’s exceedingly difficult to garner any diversification benefits now by investing in those same asset classes. Why? Looking at bonds, yields are so low today that it will be exceedingly difficult to achieve any kind of robust returns to offset stock market volatility, unless rates go negative, which we don’t believe will occur. As for equities, we now live in an interconnected world that didn’t exist 25 years ago. Global economic sectors (and the stocks that comprise that sector) tend to move in the same direction today, regardless where that sector may be located geographically. The big game changer occurred in 2001 when China joined the World Trade Organization. That event brought about a much more interconnected world, resulting in the loss of diversification benefits through international investing.
So, is portfolio diversification a concept that has now been relegated to the dustbin of history? Not at all! While it will be difficult to achieve any level of diversification by investing in stocks and bonds alone going forward, that does not mean that there not assets that can and will provide diversification benefits. They just happen to be assets that most investors currently don’t have exposure too; assets such as private real estate, private infrastructure, agriculture, private equity and private debt. To have a truly diversified portfolio in the future, investors must be willing to embrace these “non-traditional” assets.