For decades, proponents of modern portfolio theory have advised their clients that when it comes to constructing investment portfolios, diversification is critical. Stated simply, most of us are aware of the old axiom: “Don’t put all your eggs in one basket.”
This concept has become so patently obvious that few financial professionals would argue against it. Yet what does diversification really mean given today’s market realities, and more importantly, how should we apply that concept to the construction of investment portfolios?
Avoid Common Error of Insufficient Diversification
Diversification is a simple concept, but putting it into practice effectively is not so simple. Capturing all the relative risks and returns—befitting an investor’s time horizons, risk tolerance and need for liquidity—seems deceptively intuitive. Yet for most investors, a common error in allocating capital is insufficient diversification.
Many people think that what was once defined as diversification must be the only idea of diversification from that point forward. But the classic model for asset allocation – 60 percent equities and 40 percent bonds – may not represent a combination of asset classes that perform well in today’s markets during different economic environments.
Access Investable Universe of Public and Private Debt and Equity
Although the worldwide capital market system is made up of tens of trillions of dollars in public debt and equity securities, it is also made up of tens of trillions of dollars in private debt and equity holdings. Given this reality, why do we often limit our notion of the investable universe to only marketable securities?
Efficient markets arbitrate over the long-term the relative returns and risks associated with both public AND private companies. Excluding the vast private markets for both equity and debt strategies seems to fly in the face of the notion of effective diversification. We can do better.
Accommodate New Investment Realities