Spreading Your Wealth
Why Diversification Works
What's an investor to do during volatile times, when no particular asset class is looking terribly attractive? Spread your wealth – or perhaps more fittingly, spread your risk.
At times like this, says Dennis Stattman, Managing Director and portfolio manager of the BlackRock Global Allocation Fund, it's important to spread your risk across a broad set of investments. "A diversified asset mix not only provides some cushion on the downside, but also offers investors greater benefits than does limited diversification within a single asset class."
And Mr. Stattman and team would know. The Global Allocation Fund has 700 positions spread across more than 40 countries and 30 currencies. Not all assets respond to market factors in the same way, explains the veteran investor; for that reason, a more diversified portfolio tends to be better equipped to weather a range of market and economic conditions.
Nothing New, But More Important Than Ever
The concept of diversification certainly is not new. Modern Portfolio Theory, which dates back to the 1950s, describes how an investor can reduce overall portfolio risk simply by making investments in assets that are not perfectly correlated. Given a particular set of economic and market conditions, assets that are positively correlated will move in the same general direction, whereas assets with negative correlation will respond differently, moving in opposite directions. Simply put, the lower the correlation between assets, the greater the diversification benefits.
"We would argue that diversification is even more important today," says Mr. Stattman. "Investors need to tap a much broader set of investment opportunities than they might have needed when we had a secular bull market in US stocks. Broad diversification across asset classes, regions, sectors and securities remains a key element in managing the overall risk of a portfolio."
Mixing It Up With Commodities
An asset class that historically has provided strong diversification benefits is commodities. In recent years, Mr. Stattman and team have looked to gold-related securities, for example, to provide an element of safety and enhanced diversification. "Gold is one of the world's oldest mediums of exchange," Mr. Stattman notes. "Investors tend to gravitate to the precious metal during periods of economic dislocation."
The opportunity in commodities does not stop at gold. The Global Allocation team also sees positive trends for natural resources such as oil, coal and natural gas, particularly in cases where the emerging markets are the marginal consumer. Mr. Stattman explains, "Developing economies are not slowing in the same way as the developed world. They are increasingly becoming a larger part of commodity consumption and contributing to longer-term demand growth." As such, he says, any temporary price weakness for these commodities in the short-term may be creating excellent buying opportunities for the longer-term.
Ultimately, markets are unpredictable and investing inherently involves risk. Sometimes, as we were painfully reminded in 2008, there's no way around losses. "But there are ways to help minimize them," says Mr. Stattman. "We believe diversification is still the No. 1 strategy for building that type of cushion into an investment portfolio."
Global Allocation Fund
Ranked as one of the "50 Best Funds for the Everyday Investor". (US News, June 1, 2011)
Archived articles are current as of the original date of publication.