Behavioral Advisor: Is Your Portfolio Global Mush?
Most investors end up with over-diversified portfolios that are costly and deliver poor performance. The typical asset allocation model and subsequent investment in a group of diversified funds often results in a portfolio of “Global Mush” with literally thousands of tiny positions.
Just examining the equity portion of a portfolio, the table below highlights a typical set of categories along with the average number of stocks held for actively-managed funds in each category. Investors buying an average fund in each of the nine categories would end up with a staggering 1,976 positions in their equity allocation alone.
AVERAGE NUMBER OF STOCKS HELD BY EQUITY FUND CATEGORY* (July 31, 2018)
* Number of stock holdings include long positions only. Source: Morningstar, July 31, 2018.
The wholesale adoption of asset allocation models along with the introduction of other asset classes and sub-asset classes has fueled the propagation of categories and funds to the point where Morningstar now has 117 categories and 29,916 mutual funds. Firms, advisors and investors allocate across these categories with one or more funds in countless ways. The situation is further compounded by the fact that most individual funds, in efforts to dampen volatility or track a category benchmark, are over-diversified. Finally, investors tend to have buckets of money and multiple investment accounts for a wide variety of reasons. This often results in a haphazard collection of investments and holdings.
A better approach, particularly for a growth-oriented portfolio, is to invest in a handful of different specialized funds that are “truly active” with a narrowly defined strategy and high conviction positions. The result is a high-quality active equity portfolio that is strategy diverse with a few hundred well curated positions.
From the Behavioral Viewpoint
What is going on?
- Because of Herding, we want to go along with the crowd and conform. Encouraged by large firms with sales and marketing muscle we comply. Responding to prompts such as “Let’s start with an asset allocation model” and “Of course everyone needs growth and value” followed by “What about international and emerging markets?” and so on until we have one of everything.
- With so many investment choices we become overwhelmed with what is known as Choice Paralysis and inevitably; do nothing, buy a little of everything, jump from one idea to the next or simply defer to a popular simple solution.
- Using Heuristics, we simplify complex problems, make rules of thumb and take shortcuts. In this case any kind of diversification is good, and diversification becomes an ideology that goes unquestioned.
What can we do?
- Realize there is no must-have investment and you don’t need to invest in everything to succeed.
- Use needs-based financial planning to separate your growth portfolio from other financial needs and resources.
- Carefully construct a strategy diverse portfolio of 5 to 8 “truly active” managers that specialize in a specific strategy and take high conviction positions.
- Work with a financial advisor to get a complete financial picture and regularly maintain your investments.
IMPORTANT INFORMATION AND DISCLOSURES
The information provided here is for general informational purposes only and should not be considered an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. It should not be assumed that recommendations of AthenaInvest made herein or in the future will be profitable or will equal the past performance records of any AthenaInvest investment strategy or product. There can be no assurance that future recommendations will achieve comparable results. The author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions. AthenaInvest disclaims any responsibility to update such views. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of AthenaInvest.
You are solely responsible for determining whether any investment, investment strategy, security or related transaction is appropriate for you based on your personal investment objectives and financial circumstances. You should consult with a qualified financial adviser, legal or tax professional regarding your specific situation. Investments involve risk and unless otherwise stated, are not guaranteed. Past Performance is no guarantee of future results.
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