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
The axiom, “It’s a small world,” reinforces the need for more thorough diversification. The power of a robust network of business colleagues and friends can help advance a professional’s career, and networking can be powerfully extended in a world of rapidly increasing globalization. For similar reasons, we must intermix and integrate our capital in a fashion that is just as productive.
But every opportunity comes with a corresponding risk. When investing, the risk of increased globalization is increased connectedness that leads to increased asset correlation, which is precisely what investors are trying intently to avoid. Add to that the challenge of producing income for retirement in an increasingly interconnected and globalized world, and it is apparent that diversification for today’s market realities demands so much more than simplistic answers from the past.
Find out how allocations to alternative investments that appropriately incorporate exposure to both public and private debt and equities can be an important component of smart portfolio construction suited for today’s market realities.
More Information for Financial Advisors
Download the informative white paper (Diversifying with Alts: Constructing Portfolios that May Reduce Volatility and Fear-based Selling) available at behringerinvestments.com/evolve. This resource helps financial advisors build the case for allocations to alternative investments by analyzing historical returns for various asset classes and summarizing what we can learn from this data about how to further enhance portfolio diversification in today’s marketplace.
Behringer creates, manages and distributes specialized investments through a multi-manager approach that presents unique options for allocating capital, managing risk and diversifying assets. Investments sponsored and managed by the Behringer group of companies have invested into more than $11 billion in assets. For more information, call toll-free 866.655.3600 or visit behringerinvestments.com.
Alternative investments may involve higher fees, more limited liquidity, and greater risks, including higher volatility and the opportunity for significant losses, compared to traditional investment strategies. Alternative investments are not suitable for all investors.