Diversification Strategy

Date postedSep 30, 2020

One of the hallmarks of our industry, especially when it comes to diversification, is the ease with which one can achieve true diversification. The marketing pieces from asset management firms tout all-in-one, multi-asset solutions.  While it’s true that one can diversify their portfolio with the addition of various fixed income strategies, apparently one can also achieve diversification nirvana within the equity asset class as well.

How? Actually, it’s quite simple. Start with your core exposure (let’s say US stocks), add some Canadian equities, some European equities, some emerging markets, and some Asia Pacific equities. If you really want to capture the true diversification benefits that the equity markets have to offer, then let’s sprinkle in some small cap, mid-cap, maybe a bit of value exposure and top it off with some minimum volatility and multi-factor exposure.  Et voila! You’ve got the ultimate, diversified equity portfolio! Or do you?

Why do we want to diversify our equity portfolios amongst different regions, market caps, equity factors, etc.? If stock markets only went up, then there would be no need for diversification, as we would invest 100% of our money in what we believed would provide the highest rate of return. Alas, markets don’t only go up, they go down as well, and in many cases, quite severely. It’s during these periods that you want to be diversified, as in theory, diversification will “cushion” some of the downside.

With that as a preamble, we wondered if the above approach provided any diversification benefits through one of the most volatile periods in memory – the February 19th peak in the S&P 500, and the March 23rd low in the S&P 500. If there are diversification benefits to be achieved, this period would be the time to realize them. To find out if we realized any diversification benefits, we ran a correlation matrix on the following securities:

  • SPY - SPDR S&P 500 ETF Trust
  • S&P/TSX Composite index
  • EEM - iShares MSCI Emerging Markets ETF
  • IJH - iShares Core S&P Mid-Cap ETF
  • IJR - iShares Core S&P Small-Cap ETF
  • IEV - iShares Europe ETF
  • IPAC - iShares Core MSCI Pacific ETF
  • ACWV - iShares Edge MSCI Min Vol Global ETF
  • ACWF - iShares Edge MSCI Multifactor Global ETF

This was the result:


To put the chart into perspective, a perfect correlation between two assets would be 100%, meaning they move up or down almost identically. A negative correlation of 100% means they move in completely opposite directions. Any association greater than 70% is considered a strong indicator.

So, would we have achieved any diversification benefits in the period we needed it most with the broad selection of investments shown a couple of paragraphs back? The answer is no. The reality is that in time of market strife, the association between most equity markets gets close to 100%, and those diversification benefits completely disappear. It’s clear to us that if one is looking for true portfolio diversification, it will not be achieved by diversifying amongst different regional markets. One must look outside of traditional asset classes in order to gain true diversification benefits.

If you want to learn more about Kinsteds platform and diversity strategy, reach out to one of our Wealth Counsellors or our Service Team at ServiceTeam@kinsted.com.