Portfolio diversification & ITs

[TUK020]

I have read that asset allocation and diversification are the only free lunches in investment.

I have also seen studies that indicate risk reduction benefit from diversification starts to tail off after 15 different sectors, and you get into diminishing returns from further sectoral diversification, although you do get some benefit from individual share risk reduction by doubling up within sectors.

This needs to be balanced against the trading cost overhead of share purchases, which starts to carry a penalty for purchases below £1k. I tend to wait until I have got £2k to spend before making an acquisition.

If you starting investment pot is much below £15k, Investment Trusts have significant attraction for providing instant diversification without uneconomic trading costs.

For larger portfolios comprised of a diversified array of single company stocks, ITs still have attractions in that they enable exposure to geographies not offered in you local stock exchange, and also access to different sectors not well covered in said stock exchange

[G3lc]

If I was starting out now (not sure now is the right time) I would start with a selection of ITs covering different markets and then add individual companies such as say preciouses metals, health and energy that I thought could have a good outlook or be under represented or add a bit of protection to the ITs I was holding.

[88V8]

the post is nothing to do with high yield at all , ----

It could equally be read as pertaining to income stocks and ITs, so it's Ok on either board.

I agree about over-diversification.
Luni refers to it as 'sectoral philately' and sometimes 'diworsification'.

V8

[dspp]

I have read that asset allocation and diversification are the only free lunches in investment.

Moderator Message:
Just to let you know I have moved this thread to "Investment Strategies" as it is not necessarily to do with High Yield in any way. regards, dspp

[Mememe]

I have read that asset allocation and diversification are the only free lunches in investment.

I have also seen studies that indicate risk reduction benefit from diversification starts to tail off after 15 different sectors, and you get into diminishing returns from further sectoral diversification, although you do get some benefit from individual share risk reduction by doubling up within sectors.

This needs to be balanced against the trading cost overhead of share purchases, which starts to carry a penalty for purchases below £1k. I tend to wait until I have got £2k to spend before making an acquisition.

If you starting investment pot is much below £15k, Investment Trusts have significant attraction for providing instant diversification without uneconomic trading costs.

For larger portfolios comprised of a diversified array of single company stocks, ITs still have attractions in that they enable exposure to geographies not offered in you local stock exchange, and also access to different sectors not well covered in said stock exchange

Not sure it’s sectors, but individual stocks...

[Avantegarde]

Some years ago I was an elected trustee of my large employer's very big pension scheme. We spent a lot of time on investment issues. Our investment advisers had examined the benefits of diversification and had come to the conclusion that we did not really need to have more than 12 separate investment managers (assuming they were doing different things). Now, I don't suggest that individual investors should behave like big pension funds. Apart from anything else, endless fiddling with managers and asset allocations just generates costs that can eat up your dividend income. Perpetual micro analysis of returns (both losses and profits) didn't really get us anywhere. Better, I think, for private individuals of relatively modest means to stick to a simple portfolio (tracker funds and a few ITs in my case). 12 sounds a good idea to me. There must come a point when too much diversification means you just have a jumbled up international tracker fund of sorts.

[MickR]

There is also the issue with finding additional investments that you are happy to invest in. To me its pointless to diversify into areas that are just not worth investing in at the minute, just for the sake of diversification.

Mick

[88V8]

To me it's pointless to diversify into areas that are just not worth investing in at the minute, just for the sake of diversification.

Quite so.

Sectoral philately
and
diworsification.

V8

[stevensfo]

To me it's pointless to diversify into areas that are just not worth investing in at the minute, just for the sake of diversification.

Quite so.

Sectoral philately
and
diworsification.

V8

Funnily enough, I always thought that philatelic collections using a certain common theme were worth more than a generic collection.

'Diworsification' is a name that appeared during the days on TMF. So above 15 holdings, your returns may not match the number of holdings and you'd be better off buying an All World Tracker...etc..etc.

As far as I'm concerned, it means diddly squat. There's a lot more to it than that.

Steve

[88V8]

Funnily enough, I always thought that philatelic collections using a certain common theme were worth more than a generic collection.

You were right. So the notion that one has to be in all sectors - sectoral philately - is mistaken.

'Diworsification' is a name that appeared during the days on TMF. So above 15 holdings, your returns may not match the number of holdings and you'd be better off buying an All World Tracker...etc..etc..

That is the essence. Although it is a path that can be hard to follow.

V8 (alas with more than 15 holdings)

[Itsallaguess]

'Diworsification' is a name that appeared during the days on TMF. So above 15 holdings, your returns may not match the number of holdings and you'd be better off buying an All World Tracker...etc..etc..

That is the essence. Although it is a path that can be hard to follow.

I think this is one of those discussions where there's likely to be one group of investors who are happy looking at things at a purely technical level, in terms of 'returns' and 'risk', and then there's a second group of investors who are likely to still consider those aspects as being important, but who also benefit at the personal level from some additional 'investor comfort' by perhaps carrying more holdings than the first group of investors deem 'technically necessary'...

We might even argue that those in that second group, in which I'd firmly place myself by the way, might only actually benefit from a 'diversification placebo effect' by holding a larger number of investments than the one that might be necessary to achieve any given 'optimum technical benefit' that the first group of investors are happy with, but I'd still suggest that if there was a personal benefit to doing so, in terms of an investor simply 'being more comfortable' in themselves by going beyond that 'optimum technical level', then so long as that personal benefit outweighed any huge amount of additional cost in doing so, then it should still be recognised as being useful to that individual investor...

I'm a big believer in giving personal value to 'soft-benefits' like this, and think that for some investors, doing so will ultimately help to deliver the *single biggest benefit* of long-term investment, which is to simply be able to 'stay the course' over very long periods, using a personal investment strategy that suits *us*, rather than trying to mould ourselves into someone else's vision of what might be 'technically necessary'...

Cheers,

Itsallaguess

[Bubblesofearth]

There is also the issue with finding additional investments that you are happy to invest in. To me its pointless to diversify into areas that are just not worth investing in at the minute, just for the sake of diversification.

Mick

G'day Mick. Help a chap out here and name those areas?

BoE

[G3lc]

The trouble with limiting oneself to say a 15 stock portfolio is one has to be very sure one is right on the now and future, when the portfolio is created, or one has to create this portfolio with a view change it as and when stuff happens - out of the frying pan into the fire.

My choice is a larger portfolio for flexibility, I like to feel my way into a stock and add to it if and when the opportunity arises, and sometimes it doesn’t so I am left with a smaller holding than I would have perhaps preferred, another reason is having been in business for many years I am aware one has good and bad times, and good management can adapt and change but this can take time, and one can miss the boat by selling at the wrong time and buying back in at the wrong time,

Now as I am more risk adverse I’m concentrating on collecting a wide range of ITs

But as always luck plays a part.

[JohnW]

Now as I am more risk adverse I’m concentrating on collecting a wide range of ITs

But as always luck plays a part.

Would you say that luck's role is a desirable situation, or undesirable, or somewhere on that spectrum?

[G3lc]

A fact of life

[JohnW]

So, desirable, or undesirable but necessary?
Were the luck involved in stock picking and market timing less desirable than more desirable one could buy the whole market with a very broad based collection of just about every listed stock and be done with luck and get whatever returns the economy(ies) were providing. But that wouldn't deal with 'necessary'.

[Bouleversee]

"There is also the issue with finding additional investments that you are happy to invest in. To me its pointless to diversify into areas that are just not worth investing in at the minute, just for the sake of diversification."

Mick

"At the minute" neither would I but not all that long ago, it did pay handsomely to diversify from the usual suspects and buy such high flyers as WH Smith, Greggs, Hollywood Bowl*, Compass, Persimmon, James Fisher and various others and I did, which is why my total return for the previous year was 18% +. However, very few of my multiple holdings have not been affected by Covid-19 and many of those gains have disappeared. Don't tell me that luck doesn't play a huge part when we have the stalwarts like Shell also floundering and what difference does it make that a company is well run and has performed brilliantly when a pandemic virus pokes its nose in?
Fortunately, I do have some of those who have surged since lockdown, including. AZN, RB, SMT, ULVR and POLY I started with funds in my youth, only to find that when I wanted to buy my first flat, they were all down so I thought I would paddle my own canoe after that, at one point with the help of a good stockbroker, but as one's investment builds up over the years, I think it does make sense to switch to a few ITs. If you pick the right ones ("aye, there's the rub") it makes life a lot easier. They are probably better able than I to make the right decision as to when to get out of a stock due to changed circumstances and when to buy something that will fly, and actually do something about it. However, so far I have only put relatively small sums into SMT and Monks.

I couldn't tell you what my overall position is in relation to Jan 1 this year since it changes every day by several thousand and I really can't be bothered to tot up the various p/fs.

* Imagine the frustration of the management, staff and customers of HB, due to reopen tomorrow after a lot of expense and careful planning, only to find today that that will not happen for at least another fortnight. What a curveball!

I really do think that what happens from hereon will be largely down to luck and you will have to be a trader, which I am not, to benefit from it The few purchases I have made since lockdown all shot up ... till they went down again. (Haven't looked today).

[1nvest]

Diversification is more for risk reduction purposes. For some just three or four stocks might suffice. For example consider a investor who follows a Talmud advocated style asset allocation, third each :
land (UK home (£))
business (US stocks where US$ is the primary reserve currency)
reserves (gold - a commodity and a global currency)

then both their currency and asset risk/diversification is 3-way (£/$/global currencies; land/stock/commodity assets)

Their income diversification is perhaps 4-way, imputed rent, dividends, SWR, top-slice real gains.

In that context they might be the type of investor who likes relatively few stocks/high single stock focus/concentration. A third of the stock allocation in each of three stocks, 11% risk per single stock relative to the whole - not much more than what a broader stock index might hold in its largest single stock (many indexes restrict the largest single stock weighting to 10%). They might opine that they prefer to diversify across three sectors, Financial/Insurance - and select Berkshire Hathaway for that, Food - and select McDonalds, Tech and opt for perhaps a 50/50 Apple and Microsoft split. Where those each individually have economies larger than some countries, and global presence. If Buffett died shortly after having purchased BRK shares and the share priced halved their portfolio value might see a 5% decline, unpleasant, but no different to what the portfolio value might be expected to fluctuate by naturally over time.

[JohnW]

Diversification is more for risk reduction purposes. For some just three or four stocks might suffice. For example consider a investor who follows a Talmud advocated style asset allocation, third each :
land (UK home (£))

Is it right to consider your home an investment? You usually can't sub-divide the land to sell a corner to realise some cash; you can't sell it all without needing to replace it, or rent; but you can rent out the front room for a very modest return.
I'm not sure that counting it adds much to your diversification unless you plan to sell and move to a much lower cost country.

[JohnW]

then both their currency and asset risk/diversification is 3-way (£/$/global currencies; land/stock/commodity assets)

Their income diversification is perhaps 4-way, imputed rent, dividends, SWR, top-slice real gains.

In that context they might be the type of investor who likes relatively few stocks/high single stock focus/concentration. A third of the stock allocation in each of three stocks,

As sensible as diversification between assets in a portfolio is, it would still be beneficial to take advantage of diversification within asset classes if possible, such as in stocks. One could choose to be the type of investor who doesn't, but it would be more risky.
Some may wish to consider this analysis: http://www.efficientfrontier.com/ef/900/15st.htm
'The reason is simple: a grossly disproportionate fraction of the total return came from a very few "superstocks" like Dell Computer, which increased in value over 550 times. If you didn’t have one of the half-dozen or so of these in your portfolio, then you badly lagged the market. (The odds of owing one of the 10 superstocks are approximately one in six.) Of course, by owning only 15 stocks you also increase your chances of becoming fabulously rich. But unfortunately, in investing, it is all too often true that the same things that maximize your chances of getting rich also maximize your chances of getting poor.'