Invest With Aqua
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Invest With Aqua

The Importance of Diversification

How adding alternatives to your portfolio can help decrease volatility and super-charge your returns

What is portfolio diversification?

Portfolio diversification is when an investor has exposure to a number of different types of assets or assets with varying underlying characteristics. Historically the types of assets investors have used to diversify their portfolio were limited to stocks, bonds and cash. Diversification can also occur within the same asset class. For example the market capitalization, sector and the market are ways you can diversify your exposure. Additionally fund types (i.e. — mutual fund, hedge fund) and manager style (i.e. — active, passive) can add diversity to your portfolio.

Why does diversification play such an important role?

Diversification within a portfolio helps alleviate the extreme ups and downs of the market. The basis for this theory is that different assets are subject to different macroeconomic factors. Diversification is a tool to hedge. It provides defense or downturn protection to your portfolio. The more investments are uncorrelated the more balanced your portfolio is. So if one aspect of your portfolio is under stress and underperforming the other pieces of your portfolio are not, and they continue to provide positive returns.

One thing to be mindful of — in recent years, stocks and bonds are often impacted by the same, small number of macroeconomic factors. This means that your traditional 60/40 stock and bond diversified portfolio, isn’t as diversified as it once was.

Check out our prior blog post Why are alternatives important? for further detail.

Introducing alternatives to your portfolio construction

Alternative investments are a great way to add uncorrelated assets to your portfolio. Alternatives are subject to different risk factors than the public markets and have a long history of solid returns.

Returns of a diversified portfolio including alternatives

The collective difference that a truly diversified portfolio can return is what Nobel Prize winning economist Harry Markowitz once called “the only free lunch in finance.”

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 see returns at ~8% but your risk profile is cut in half to ~8%. Additionally, the 100% equities portfolio has a the “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 portfolio really protects against market downturns.

Everyone knows the common phrase “historical performance is not indicative of future returns.” And while we cannot predict how alternatives will perform in the future, it is clear from the past that they have provided significant protection.

Here at Aqua we want everyone to have access to alternatives, which historically have not been accessible to retail investors. Head over to www.investwithaqua.com to check out our latest offerings to add to quality alternatives to your portfolio today!

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