STA Weekly Report – A Note About Diversification and Uncorrelated Strategies
Written by Luke Patterson | Thursday, March 7th, 2019
INSIDE THIS EDITION: A Note About Diversification and Uncorrelated Strategies Stock Indexes Are Holding Steady What is Asset Allocation and How Do I Integrate it into My Financial Plan? 401k Plan Manager*Updated on 12/31/2018
Going forward, it is entirely plausible that returns in traditional portfolios and asset classes may be muted. After all, we have been in a period of unprecedented central bank intervention that likely pulled forward future returns as the economy recovered from the financial crisis.
As the chart below shows, the 10-year cumulative real return of a U.S. balanced portfolio (60% stocks/40% bonds) have actually been pretty good on a risk-adjusted basis compared to history going back to January 1900.
During these last 10-years the real yield generated by traditional balanced portfolios (60% stocks/40% bonds) has frequently trailed historical levels as capital has increasingly been returned to shareholders via buybacks rather than dividends.
Additionally, we have until recently experienced abnormally low levels of volatility. And in those rare instances when we have had episodic volatility, correlations across the asset class spectrum have been positive. Meaning, that financial assets have all tended to move in the same direction thus making the benefits of diversification hard to realize while traditionally low correlation assets have become nearly impossible to stick with.
These outcomes have understandably led many investors in both the accumulation and distribution phases to question whether the pursuit of diversification and including uncorrelated assets within a portfolio are merely a fool’s errand.
We argue that these goals are not a waste of time, effort, or capital. In fact, these two aspects of portfolio construction (diversification and lower correlations) are among the most important things an investor can do to be successful in the long-term, despite periods of seemingly underwhelming results.
To do them well however, investors must accept a couple of things. First, investors must have a clear understanding that uncorrelated assets in no way will be uncorrelated at all times. In fact, it is highly probable that correlations over shorter term time periods will be above 0. In other words, over short periods like 1 month or 3 months, uncorrelated strategies or assets may exhibit positive correlations with traditional assets like the S&P 500. However, in the longer term, say three years, uncorrelated assets will tend to have correlations to traditional assets that are close to zero. What this means is that investors must give uncorrelated assets and strategies sufficient time to deliver what they advertise –better risk-adjusted returns for the overall portfolio.
Second, diversification does not mean that when the equity market declines that diversifying assets will necessarily produce positive returns. If that is the goal, then a hedge is more likely what the investor is looking for. Instead, diversifying assets are intended to generate return streams that are unrelated to what is occurring in the market; positive or negative. Over time, this should deliver a smoother ride
with less volatility and make achieving investor goals and objectives more likely.
Stock Indexes Are Holding Steady
Major U.S. stock indexes have backed off from potential overhead resistance at their November peaks. But little damage has been done to their 2019 uptrend.
Chart 1 shows the Dow Industrials finding support at its 20-day moving average (green) line. While Chart 2 shows the S&P 500 doing the same. The SPX would have to drop below that initial support line, as well as its red 200-day average, to signal a more serious setback. Sectors are pretty evenly split between small gains and losses today. Communications, cyclicals, and REITS are in the lead; energy, industrials, and materials are lagging behind. Transportation stocks, which remain stalled at their 200-day average, are weighing on the industrial sector. Small cap indexes also continue to meet resistance at their 200-day average, and are starting to lag behind larger stocks.
Weekly Global Asset Class Performance
If you have any questions, please feel free to email me at email@example.com.
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
What is Asset Allocation and How Do I Integrate it into My Financial Plan?
Written by: Scott Bishop, MBA, CPA/PFS, CFP®
As a long-time financial planner, I find it very important to make sure that a client’s portfolio is aligned with their overall financial plan. Many investment advisors or planners try to figure out a client’s portfolio allocation via a questionnaire. Although some questionnaires are good and some are bad, I feel that the best allocation can only be determined if it is coordinated with their overall financial planning goals and objectives. Many investors (and even financial advisors) use allocation targets to try and beat benchmarks like the S&P 500. However, how is beating a market a true goal in and of itself? Shouldn’t trying to have a higher probability of meeting or beating their financial goals and objectives be the true “benchmark” or goal of your or anyone’s portfolio?
Important Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.
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