Diversification key to robust portfolio design


The key to designing a robust portfolio that can withstand a multitude of market pressures is choosing stocks and funds that have diversification across all asset types, investment styles and industry sectors . That way, if one part of the market struggles, other areas take up the slack and lift the portfolio.
For instance, right now the best stock market gains are being achieved by a core group of technology and internet-based stocks that Wall Street dubbed the FAANG stocks.  FAANG is an acronym that stands for Facebook, Apple, Amazon, Netflix and Google.  We have invested in these stocks because we have been impressed by their fundamentals, and, as a result, we have made nice gains in this sector. These companies have revolutionized the way people all over the globe buy and sell goods, get their news, and build social networks. Indeed, it is hard to conceive of modern life without them.  Their ubiquity in our personal and social lives is reflected in their dominant economic position, which is likely to continue for the foreseeable future.
It’s tempting, for even the most disciplined investors, to invest heavily in those parts of the market that currently have the best returns.  But such a narrow focus carries with it hidden dangers.  The FAANG stocks are in such a dominant position because they disrupted and overturned successful business models of the past.  Does anyone remember Hewlett Packard, or IBM?  These companies are still around, and even making a profit for their shareholders, but they are no longer the dominant players they once were and their stock price reflects their relative decline.   You can be sure that in a business incubator, or even a garage, the next disruptive technology is being conceived that will knock one or more of these dominant players off their perch.
That is why, even when the best gains are to be had in a narrow segment of the market, we believe the best retirement portfolios contain a healthy dose of diversity.  As the FAANG stocks have soared their stock prices have become more and more expensive.  Meanwhile, there are other segments of the market that look very good from a price-to-earnings and price-to-sales standpoint.  The investment department has done a deep dive into those parts of the stock market and looked for companies that were growing their revenues while maintaining their costs.
No longer just a way to describe the relative mix of stocks and bonds in a portfolio, “diversification” comes in many forms.  In the example above, the investment department maintained diversity among stocks based on “value” criteria.  Another diversification factor we use quite frequently is based on industry “sectors” such as healthcare, energy, banking and consumer goods.  Each sector has its own challenges and strengths but they each respond to different market forces.  An adverse event to the banking sector, like falling interest rates, will not affect the healthcare sector at all and may even be boost to a sector such as consumer goods.
Modern portfolio construction has benefited greatly from advances in technology.  Because of super computers and satellite communications it is now possible to invest in companies all over the globe as safely and easily as investing in companies here in America.  Because of this, we are able to add another level of diversity to our portfolios based on a “geographic” criterion.  Through the use of Exchange Traded Funds we have gained exposure to a broad array of Emerging Market and European stocks, which has enhanced the performance of our portfolios this year.
The goal of all this diversification is to gain exposure to those parts of the segmented market that are most likely to gain from prevailing economic conditions while minimizing the risks to the portfolio.