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Do You Really Have a Diversified Portfolio?

Portfolio / Learning to Invest Oct 13, 2009 - 07:18 AM GMT

By: Andrew_Abraham

Portfolio

I have heard so many times when speaking to investors that they have a diversified portfolio. I ask further and I have been told that they maintain a diversified portfolio of stocks consisting of both domestic and international companies. My immediate question is, are you really reducing your risk? Especially in these times it is paramount to have a diversified portfolio and try to mitigate some of inherent risks.


Digging a little bit deeper if you would want to consider yourself diversified, you have to determine what the relationship is between the movements of each stock in your portfolio compared to the change in a specific benchmark. For our purposes, we will use the S&P 500 since it is the most popular benchmark. The S&P is then assigned a beta of one and your stock’s beta is determined by its relationship to the S&P.

For example, if the S&P moves 10% over the last year and your stock moves 5%, your stock has a beta of .50. If your stock moves 20%, then you have a beta of 2. We believe that most stock portfolios not only have a positive correlation with the S&P, they also have a higher beta.

So, if you purchase different companies which are either listed in the US or are on major international exchanges are you reducing your risk through diversification? Of course, the answer is NO! The world stock markets have been moving in unison for some time now.
True diversification is when you place money in a different asset class which has no correlation to your other asset classes.

One way to achieve true diversification and therefore reduce the overall risk to your portfolio is to add commodities to your strategic asset allocation. To elaborate further consider a commodity trading advisor whose model is based on trend Following. This can assist in compounding money overtime. There are managers who have compounded money since the 1970s continuing till today (Campbell & Co and Bill Dunn).

You need to be aware there are risks in commodity trading .The goal of a successful commodity trading advisor is to try to lessen some of the volatility and risks. Many times, groups of commodities move as a group. When you are invested and on the right side of the move it is great, but these trends can turn around very quickly. An example is the energies seem to move together…as do the grains….interest rates and even currencies. You need to verify that your commodity trading advisor is aware of group risk. Actually you need to verify how the commodity trader defines risk. There is risk per trade, risk per sector as well as total portfolio risk.

There are numerous ways in order to invest in commodities. I would definitely suggest against an index of commodities. Preferably investing with a trend following Commodity trading advisor who understands risk would be my suggestion. Commodity trading advisors can go long or short and take advantage of any trend. It is important for the commodity trading advisor to trade a large basket of commodities. No one ever rings a bell nor is it advertised in the newspaper when there is a move in commodities (just after the fact).

As I stated earlier there are commodity trading advisors who have been compounding money since the 1970s and 1980s. They have compounded annual rates of returns in the mid teens. When you compound money over time with returns in the mid teens you compound your way to wealth. I personally have done it. It takes patience and discipline to go through the evitable draw downs. This is not just my wonderful thinking. An example is of PIMCO, one of the largest investment managers in the world, commissioned Ibbotson Associates to research the historical role of commodities in strategic asset allocation. When asked the results of this study, Robert Greer, a senior executive at PIMCO stated “Historically, Ibbotson found that commodities have provided high returns, diversification, a hedge against inflation and an improved risk/reward profile in strategic asset allocation.”

This statement seems to suggest that commodities should be the fourth asset class along with stocks, bonds, and real estate

Andrew Abraham
www.myinvestorsplace.com

Andrew Abraham has been in the financial arena since 1990. He is a commodity trading ddvisor and co manager of a Commodity Pool. Since 1993 Andrew has been a proponent of quantitative mechanical trading programs. Andrew's major concern is not only total return on investment but rather the amount of risk that one would have to tolerate in order to achieve returns He focuses on developing quant models that encompass strict risk adherence and correlation. He has been a speaker at conferences as well as an author of numerous articles. Andrew has spent years researching ideas that have the potential to outperform indices as well as maintain fewer draw downs.

Visit Angus Jackson Partners (http://www.angusjacksonpartners.com) Contact: A.Abraham@AngusJackson.com (mailto:A.Abraham@AngusJackson.com)

© 2009 Copyright Andrew Abraham - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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