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Jan 02

Common Sense view on Diversification

On December 30, Robert Jaeger wrote an excellent piece on diversification for the Financial Times (article can be found here) that palces a bit of common sense around portfolio construction as it probably should be. As he mentions…

In the good old days, asset allocation revolved around three main asset classes: stocks, for long term growth; bonds, for income and safety; and cash, for liquidity

 …unfortunately recent years saw this simple asset allocation rule forgotten. He goes on to say…

cash and plain-vanilla bonds were disdained as “drags on performance”. The equity portfolio evolved to include everything from developed to frontier markets. The bond portfolio evolved to include an alphabet soup of complex products that investors didn’t fully understand. And the new category of “alternative assets” (private equity, hedge funds, timber, et al), many of which are illiquid, seemed to offer a way to enhance diversification without giving up returns.

As we all should know by now (although many are still in denial), these so-called diversifiers failed to diversify during the global financial crisis and we ended up holding portfolios that are illiquid (motrgage trusts, fund of hedge funds, and hybrid property funds) and we have dissatisfied clients.

Now I do believe that investment simplicity reined supreme in 2009  and I hope it continues into 2010. Happy New Year to all!

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