Why diversification should pay off in 2017 and beyond
From: news-journalonline.com
Look at any one of the last few years and it’s easy to make the case that diversification is broken, and that you don’t need it.
Look out longer, however, and the forest becomes visible through the trees.
That said, after a series of years in which diversification didn’t pay off, 2017 may be the time where maintaining a diversified portfolio meets both short- and long-term agendas.
That’s because while market observers seem to agree that the early part of the year will be strong before a market setback or slowdown begins in the summer, they disagree on which sectors, countries and parts of the world will thrive or fizzle, and in fact foresee situations where best guesses on what will work will be bullseye right or dead wrong.
In recent weeks on my show, “MoneyLife with Chuck Jaffe,” for example, several investment strategists called for energy stocks to be strong and defensive plays like utilities to be weak, but immediately said that if the market doesn’t follow their expected lines – where defensive stock plays struggle this year – the outcome would be reversed.
In that case, diversifying a portfolio – spreading cash into different sectors and asset classes – ensures that some assets will be gaining even as others lag behind. That creates the smoother long-term ride, even in times of unsettling market volatility.
But that doesn’t mean diversification feels good at all times.
In 2016, diversification only “worked” because nearly any asset class you put money into was up; of the 110 asset categories tracked by Morningstar Inc., exactly half gained at least 5 percent last year. Nearly 90 different categories posteded gains.
In those conditions, you don’t really need diversification in order to feel good. While an investor certainly would have enjoyed seeing their average precious-metals fund gain more than 50 percent, they were hardly panicking with small stocks gaining 20 percent on average or large-cap gains in double digits.
In 2015, a diversified investment portfolio didn’t offer much protection from the market’s gut-wrenching volatility, because, again, virtually every asset class moved in lock-step during every significant twist and turn.
Moreover, there was plenty of evidence that having a diversified portfolio in 2015 didn’t pay off because the global market laggards were so bad that they ate up the gains from the winners.
The Vanguard Investor Index – an asset-weighted measure of the performance of all Vanguard funds and annuities – was down in 2015 for the first time since 2008. It was just the fifth decline in the last quarter-century, due largely to losses in emerging markets and international stocks outweighing small gains for domestic stocks and bonds.
Then there was 2014, when investors felt betrayed by diversification because the most attractive place to invest was large-cap domestic stocks, the very place investors typically find most comfortable. Spreading money around was not only emotionally discomforting, but reduced overall portfolio returns significantly.
Bringing the process back to 2017, the case against diversifying this year is likely to come from the bond side of the portfolio; historically, bonds struggle in times of higher growth and inflation, two conditions expected for 2017 and beyond.
But experts say the point of diversifying isn’t for what it does in any one year or short-term time horizon.
“Diversification is an effective strategy when you are investing for the long-term, when you are investing with a specific goal in mind …; looking to build and protect wealth over a long time,” said Niladri Mukherjee, director of portfolio strategy for Merrill Lynch’s Private Banking and Investment Group. “Diversification gives you risk-adjusted returns that are better than if you were just invested in one or two asset classes which in any given year or quarter would be very difficult to project where they go.”
Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management said that diversification works when looked at over long-periods of time, and typically after periods when people insist it has failed.
He noted the late 1990s, when the Standard & Poor’s 500 had outperformed international and emerging markets by a wide margin, to the point “where people didn’t want to buy anything but the S&P.”
After that, the Internet bubble burst and the trends reversed.
The investor who had their eggs in different baskets mitigated the pain of the market’s meltdown.
Diversification doesn’t pay off constantly or consistently month -by-month or year-by-year, Schutte noted, but you’d rather be right about the next 12 or 24 years than the next 12 to 24 months.
“I don’t know that this is the year that international outperforms, but I do know that, long-term, valuation matters and it dictates which markets do better,” Schutte said. “Right now, valuations in the international and emerging markets are cheaper, and people are less exposed to them because they have piled heavily into last year’s best performing market, which was the U.S.
“That makes this a good time to diversify;” he added. “It may not pay off this year but ultimately wit will pay off.”
