The Cornerstone – April 2013

“Diversification at the Crossroads”

 We have seen a very good equity market over the last year – not totally unexpected given the large amount of cash available, low interest rates, and an overall improvement in the economy here in the US. The returns are largely from US stocks, especially those that have a dividend for people to help supplement their income. Very little has come from other areas such as cash/fixed income or international strategies.  So why not just have those US stocks? Why diversify at all? No one, no matter how smart, can tell you what will be the best place for your money tomorrow, but we do recognize opportunities in different areas and that’s what we try to do – diversify without hurting our returns.  Not having all the eggs in one basket is more than a proverb – it is designed to reduce overall portfolio risk – if you work on it.  It’s a process of combining equities, fixed-income, alternative investments as well as other products, domestic and international, because they are uncorrelated and by combining them gives us less volatility.  Ideally, we want to have a less volatile portfolio (less dangerous) without hurting our returns.  The question: What if diversification no longer works? Unfortunately, I think we’re headed that way. The last several years have seen previously uncorrelated asset categories become more and more correlated.  That is, they are beginning to act “more alike” than “not alike” when situations occur.  Diversification then – adding different asset classes to smooth out volatility, is working less and less well.  We’ve noticed this, and have slightly turned the ship to include some new ideas to help our portfolio construction: 1)      A larger part of the portfolios will be theme based: For example, we know that the opportunity cost of not owning equities will become too great for investors not to participate; We are beginning to see a cash-financed mergers and acquisitions wave in the US, which will likely get bigger; Small US banks may outperform their big brothers; Volatility may be back in the news later this year; The Japanese Yen may likely continue to depreciate, and so on. We will begin to expand on these ideas and themes and use them in a more direct manner. 2)      Portfolios will have to be more durable.  There is and will be a “new normal” going forward, that will certainly test us.  This does not mean more defensive or “bulletproof” portfolios, rather much more fluid ones that will require more work, more willingness to change, and to be smart about returns – and that’s just my role! 3)      Risk is no longer just one of the factors to discuss when developing a portfolio.  It’s THE factor that we now start from, and then determine if the time frame, return probabilities and financial base of the client is acceptable.  Think of it as “risk budgeting” in that we are not eliminating risk, rather we use it as a more stable parameter. The value I try to bring to you is a transparent, repeatable process that can help us mitigate negative market events, capture positive ones and be flexible enough to change when necessary.  Remember that no strategy works forever and be especially aware that it’s the portfolio – not the market- that matters. Welcome to Spring – and as always – Thank You Very Much for Your Business!                                    Phil The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  “Stock investing involves risk including loss of principal. Past performance is no guarantee of future results.”