What is Diversification?

Trying to predict the capital markets is nearly impossible. Many professionals have spent their lives attempting to consistently forecast market movements, only to be humbled by their inability to do so. Among all the complex investment strategies and algorithmic trading, diversification stands out as the most reliable and proven approach.

Harry Markowitz, a Nobel prize-winning economist, summed it up nicely: “Diversification is the only free lunch.” At its core, diversification means spreading your investments across multiple asset classes, companies, and strategies. In simpler terms, it means not putting all your eggs in one basket. This approach helps reduce the impact of any single investment's poor performance on your overall portfolio. By diversifying, one bad investment won't ruin your entire portfolio. Just as a skilled gardener plants a variety of seeds, a wise investor diversifies their portfolio.

Benefits of Diversification

Risk Mitigation: By spreading your investments across different asset classes, industries, and geographies, you can lessen the impact of poor performance from any single investment on your overall portfolio.

Reduced Volatility: Investors usually dislike seeing their portfolios fluctuate greatly over short periods. Diversification can lower portfolio volatility, helping investors stay committed to their long-term plans.

Consistent Returns: A well-diversified portfolio will have more stable and consistent returns, helping investors achieve their goals and objectives with greater certainty.

Psychological Benefits: Diversification can reduce the stress and anxiety that comes from having your portfolio rely on a single investment.

Implementing Diversification

Diversification is both an art and a science. Here are some key points to consider:

Think Globally: Investors often prefer their local investment markets because they are familiar with them. Diversifying across different countries can reduce the impact of a single country's economic risks.

Know Yourself: Work with an advisor to understand your personal risk tolerance and capacity. Diversification should align with your goals and personal circumstances.

Utilize Multiple Asset Classes: Just as individual companies differ, so do asset classes. Include stocks, bonds, and private asset classes within your portfolio. Have more arrows in your quiver.

Regular Review: Markets change over time, and so will your portfolio. Stick to your long-term plan by rebalancing and ensuring diversification remains intact.

Exploring Diversification Further

Diversification is more than just spreading investments across different asset classes; it involves navigating various types of risk inherent in capital markets. While the benefits of diversification are well-known, it is essential to understand why it is becoming increasingly challenging in today's environment.

Understanding Correlation and Its Challenges:

Correlation refers to how the prices of different assets move in relation to one another. Traditionally, diversification relied on assets having low or negative correlations, meaning they moved independently or in opposite directions. However, in today's financial landscape, achieving effective diversification is becoming more difficult due to rising correlations between asset classes.

Global Stock Market Correlation: With globalization and interconnected financial markets, most stocks show high levels of correlation. Economic events and market sentiment often drive stock prices together, making it tough for investors to find truly uncorrelated stocks.

Global Economic Market Correlation: The globalization of economies has led to increased correlation among global economies. Economic trends and geopolitical events can cause synchronized movements across different markets, reducing the effectiveness of geographic diversification.

Bond Market Correlation: Bonds, traditionally considered a safe haven asset, are also experiencing higher correlations, especially during market stress. Factors like interest rate changes and macroeconomic indicators can affect bond prices across different markets simultaneously.

The Role of Private Assets in Diversification

Despite the challenges in today’s market environment, private assets offer a potential solution. Private assets, such as private equity, private credit, and real assets, often have lower correlations with public markets. These assets are less influenced by short-term market fluctuations and can provide stable returns over the long term. Including private assets in a diversified portfolio of traditional stocks and bonds can enhance risk-adjusted returns and reduce overall portfolio volatility.

While private assets offer diversification benefits, accessing these markets requires specialized knowledge and resources. Partnering with experienced wealth managers or investment firms, like Kinsted Wealth, can provide investors with access to private investment opportunities tailored to their risk tolerance and investment objectives.

Summary

Diversification remains the cornerstone of prudent investing, but effective implementation requires understanding correlation and evolving market dynamics. By embracing a diversified approach that includes private assets, investors can navigate the challenges of correlated markets and build resilient portfolios positioned for long-term growth and stability.

At Kinsted Wealth, we prioritize diversification in investment strategies, offering access to private assets alongside traditional stocks and bonds. In today’s changing investment landscape, diversification is key to resilience. Private markets provide a range of alternative assets like private equity, credit, agriculture, infrastructure, and real estate, enhancing portfolio resilience. Embracing private markets strengthens portfolios against uncertainties and fosters sustainable growth. Interested in diversifying your portfolio? Contact one of our Wealth Counsellors to craft a personalized strategy aligned with your goals and circumstances.

Kinsted Wealth is a leader in high net worth wealth management in Canada, providing tailored strategies to meet the unique needs of institutional investors and individuals seeking investment management in Calgary. Our firm, a Calgary investment firm, is dedicated to helping you achieve financial stability and growth through a well-diversified portfolio and effective investment strategies.

Regards,
Kinsted Wealth