The Importance of Diversification

How adding alternatives to your clients’ portfolios can help decrease volatility and super-charge their returns

What is portfolio diversification?

As a financial advisor, portfolio diversification is crucial for mitigating risk and maximizing returns for your clients. It involves investing in a range of different types of assets or assets with varying underlying characteristics. Traditionally, investors have diversified their portfolios using stocks, bonds, and cash, but diversification can also occur within the same asset class. This can include diversifying by market capitalization, sector, or geographic region. Additionally, fund types, such as mutual funds or hedge funds, and manager style, such as active or passive, can add diversity to your clients’ portfolios.

Why is diversification important for financial advisors?

Diversification is a powerful tool that helps protect your clients’ portfolios against the extreme ups and downs of the market. By investing in a range of uncorrelated assets, you can create a more balanced portfolio that is less susceptible to market fluctuations. However, in recent years, stocks and bonds have become more correlated, making traditional 60/40 stock and bond portfolios less effective at diversification.

Introducing alternatives to your clients’ portfolio construction

As a financial advisor, you can add uncorrelated assets to your clients’ portfolios by introducing alternative investments. Alternatives are subject to different risk factors than the public markets and have a long history of solid returns. These can include private equity, real estate, commodities, and hedge funds.

Returns of a diversified portfolio including alternatives

A diversified portfolio that includes alternatives has historically provided strong returns and lower risk. As you can see in the chart below, a portfolio that is 100% stocks historically has had a ~9.5% return but 15% of risk. If you look at a portfolio with 37% equities, 10% bonds and 53% alternatives, you can achieve returns at ~8% but cut your risk profile in half to ~8%. Additionally, the 100% equities portfolio has a “worst down day” as losing 51% of value. The 53% alternatives portfolio (in green below) has the “worst down day” at just 16%. This shows that the addition of alternatives to your clients’ portfolios can effectively protect against market downturns.

It’s important to note that past performance is not indicative of future returns. However, it’s clear from historical data that alternatives have provided significant protection in the past.

As a financial advisor, you want to provide your clients with access to quality alternatives. Aqua helps simplify private markets investments for financial advisors. Contact us to learn more about our platform and how we can help you diversify your clients’ portfolios.