What is old is new again. We always joked around that if you wait long enough that thing that was so “in-fashion” years ago will come back around and be the new “in” thing again. Well, it is happening in the financial world. No, I am not talking about fractional stock pricing or 8% one- year CD’s. I am talking about simple asset class diversification that actually works the way that all those Nobel Prize winning economist (and my college professor) talked about.
For the longest time since the Market Crisis in 2008, anytime there was a glitch in one asset class, it seemed like it dragged everything else down with it. Or if Europe yawned, that contagious yawn spread around the rest of the global markets. All these market and asset classes that traditionally had this low correlation to one another all seemed to be converging, like a financial “black hole”. So that idea of asset allocation to diversify the risk in your portfolio seemed to really be thrown out the window. I can only imagine what those college professors are saying now that they have all those students raising their hands saying “yah, but…”.
Now, if you were smart enough to just stay the course and not run for shelter because you thought the sky is falling, you would have basically made your money back, and then some, by now. However, it was a bumpy ride getting it back with the market volatility feeling like a wild rollercoaster ride. Many people jumped off the ship because their diversified asset allocation strategy to lower that portfolio volatility wasn’t working.
However, over the last year or so, the strangest things have been happening. No, Bell Bottoms are not back, but it seems like diversification is back and WORKING again. Some of the first signs were last year when the Emerging Markets were having a horrible year, yet that didn’t hamper the returns of the rest of the international markets. Now this year, those people who had Emerging Markets as part of their asset allocation (and kept adding to it while things were not going so well last year) are in love with Emerging Markets because they bought low.
Bringing it closer to home, this year the Small Cap Market that has had a great run for the last couple years has finally been letting off some steam. In January the Russell 2000 had around a 7.5% drop, from March to May it came very close touching that 10% correction mark. And again here in July it has had over a 5% drop. Now a few years back when one of the markets would have hit a pot hole like this, the rest of the markets, like the S&P 500, would hit the same pot holes. However, with the exception of January, this year the S&P seems to be moving around those pot holes and smoothly sailing along. So, instead of sitting around getting motion sick with all the ups and downs of our portfolio, we are able to have a smoother ride and also take some of our gains from our large cap holding and buy more small caps during these rocky times. Similar to Emerging Markets when we bought low, we should see the benefits of adding to these small cap holdings down the road. However, most importantly our portfolio is not experiencing all the volatility of one asset class dragging the rest of the portfolio’s asset classes down with them.
Always remember, investing is not a sprint, it is a marathon. Have that long term prospective, design a well diversified portfolio, either by yourself or with your Investment Advisor (preferably one of us here at Bloom Asset Management), and rebalance occasionally so you can always be taking some of those profits off the top and add to some of those quality positions still at some low points. Oh yes, and let’s hope that Parachute pants don’t make it back to the sales racks.