Gsphere Technology Helps Portfolios Visualize Diversification
9 out of 10 investment professionals I meet have portfolios that suffer from incomplete diversification. Disturbingly, they sell on the merits of diversification without considering the full diversification picture.
Incomplete diversification originates from portfolios that are structured to contain a large holding quantity. Portfolios having hundreds, or even thousands, of stocks almost always have incomplete diversification.
Holding many positions inside of a portfolio represents half of the diversification picture. The other half, the challenging half, rests within the relationships of the assets. The relationship of portfolio assets creates systematic risk, also known as market risk.
If your portfolios’ positions often move in unison, you most likely have poor diversification resulting from the relationship of the assets in your portfolio. You need to better analyze the entire diversification picture. Our Gsphere technology can help.
When you hold a large number of assets, you have good non-systematic diversification. Non-systematic diversification is synonymous with idiosyncratic risk diversification. This is the risk of loss relating to company specific criteria.
All diversification can be reduced to either systematic or non-systematic varieties. Given the nature of risk, your diversification is only as good as its weakest link. Your own ability to follow a plan and withstand emotional reactions to market conditions is a homogenizing influence that can ruin an otherwise well diversified portfolio. This could be incomplete diversification.
Equally devastating, and equally prevalent, is confusing good idiosyncratic diversification for good total diversification. If your portfolio is only strong in non-systematic risk, you probably have bad diversification. This is especially true for those who own funds rather than individual equities or bonds. Why you ask?
Typically, owning many positions causes investors to take on more systematic risk. If your portfolio is only as diversified as your weakest link, and your weakest link is systematic risk, then owning yet another position is unlikely to help. It is difficult enough to construct a portfolio of 5, 10 or even 15 uncorrelated positions. It is nearly impossible to build a portfolio of 100, 200 or 500 uncorrelated positions. Adding another position, without regard to the positions relationship to the rest of the portfolio, is probably harmful to proper diversification. Investors who trade greater idiosyncratic diversification for less systematic diversification have incomplete diversification.
Do your portfolios potentially contain a lot of systematic risk? Contact Gravity Investments and learn more about how we can help your portfolios experience the power of True Diversification.