Diversification Works (over time)

Investment diversification works, but not in all short-term periods. 2018 was one of those periods.

Charlie Bilello of Pension Partners shares the great chart below. This chart shows the annual performance of 15 different investment classes since 2008. If you focus on the 2018 column, you’ll see that only one of the 15 asset classes tracked (US Cash) had a positive performance for the year. That’s only 7% of the asset classes! It’s very unusual for the bond markets to be in the red in the same year where the stock markets have lost value. Even the horribly scary 2008 had 33% of the asset classes (most fixed income categories and gold) showing a positive performance.

Fortunately, most of these losses were small as compared to recent bear markets. As you can see in the chart below, the range of returns was very compact. Since 2008, the difference in performance between the best and the worst asset class has averaged over 46% - last years’ difference was only 17%.

Now that I’ve got the bad news out of the way, let me share some positives with you:

Client portfolios were conservatively positioned throughout the year. This reduced the impact of the fourth quarter’s market declines.
A good number of the Fed’s interest rate hikes are behind us and we are finally getting some return on bonds and cash. Although the bond markets are expecting few or no interest rate hikes in 2019, I’m continuing to avoid longer-term fixed-income holdings.
Although I would love to say that client portfolios avoided the losses of US and foreign stock markets, this is not the case. I did reduce US small-cap holdings and avoided REITs, gold and commodities – these all helped performance. Of course, I avoided the hype surrounding Bitcoin, which was down 71% for the year.
Several of our holdings had a decent year. One long-time holding, a widely diversified retail property real estate investment trust, performed quite well. The non-agency mortgage bond fund, alternative lending fund, and public/private real estate fund I use in client accounts all ended the year with positive single-digit performance.
My rebalancing strategy takes advantage of these volatile periods. When asset classes are performing well, we’re taking profits and reinvesting in areas that aren’t performing as well. This is not rocket science – it’s good old “selling high and buying low.” This means that through 2017 and the first three quarters of 2018, we were selling US equities and using those proceeds to purchase non-equity holdings. When the market dropped, we took the opportunity to do the opposite. I’m confident that this will increase client returns over time.

I’m expecting to be making a few changes to client holdings in the early part of 2019. Despite the correction, I’m still concerned that the next 10-year returns will be lower than we’ve been used to. This continues to lead to client portfolios that include a nice mix of alternative investments.

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