When a “Diversified” Portfolio Might Not Really Be Diversified

Published: October 6, 2016

Few investment professionals would argue against the value of a diversified portfolio.  True diversification helps to:

  • Limit your portfolio’s downside risk from over exposure to any one asset category, industry sector or holding – if there is a downturn in part of the market or a drop in a particular company’s price, broader diversification can mitigate the negative impact.
  • Reduce volatility – if your portfolio is diversified across asset classes, industry sectors and holdings in individual companies, losses in one investment vehicle in your portfolio may be offset by gains in another, potentially helping to smooth out wide swings in returns.

 

Some investors take the idea of diversification further by utilizing more than one manager within an asset class, seeking to benefit from each manager’s best ideas, differences in philosophy, investment themes, processes and holdings.  Their thought may be that if one manager provides diversification across holdings, two or three should be even better in helping to manage risk.  In other words, if one manager underperforms, investing in multiple managers within an asset class could still reap positive rewards.

What investors may not realize, however, is that different managers often favor the same companies, particularly if the managers are investing in the same asset class and style category.  A recent look at four mutual funds*, the Fidelity Blue Chip Growth Fund, The Growth Fund of America, Vanguard U.S. Growth Fund and the Rowe Price Blue Chip Growth Fund, revealed the following about their top holdings:

  • All four funds held Alphabet and Amazon
  • Three of the funds held Facebook, Microsoft and Visa
  • Two funds held Home Depot, MasterCard and Broadcom

 

According to a Morningstar publication**, overlap is even more prevalent when you own multiple funds run by the same manager.  In other words, your diversified portfolio may not be as diversified as you think, and may be exposing you to additional risk.

At Klingenstein Fields Advisors we help our clients use diversification as a tool to balance requirements for growth, income and the management of risk.  While we encourage clients to consolidate their accounts with us so that we can take a comprehensive approach to managing their assets, we understand that this is not always possible.  With that in mind, we plan to enhance our systems in the coming year, by adding aggregated reporting tools, which will provide a total portfolio view to help us identify unseen overlap risk that may occur with multiple managers.

*Fidelity Blue Chip Growth Fund, The Growth Fund of America, Vanguard U.S. Growth Fund holdings are as of 8/31/2016 and T. Rowe Price Blue Chip Growth Fund holdings are as of 9/30/2016

**Morningstar: Portfolio 100, Avoiding Overlap When Building a Portfolio

 

Important Disclosures

This material is provided for informational or educational purposes only and should not be construed as investment, accounting, tax or legal advice. Always consult a financial, tax and/or legal professional regarding your specific situation. This communication is not intended as a recommendation or as investment advice of any kind. It is not provided in a fiduciary capacity and may not be relied upon for or in connection with the making of investment decisions. Nothing herein constitutes or should be construed as an offering of advisory services or an offer to sell or a solicitation to buy any securities or a recommendation to invest in any specific investment strategy. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future returns. The views expressed herein are as of a particular point in time and are subject to change without notice. The information and opinions presented herein are general in nature and have been obtained from, or are based on, sources believed by Klingenstein Fields Advisors (“KF Advisors’) to be reliable, but KF Advisors makes no representation as to their accuracy or completeness. Although the information provided is carefully reviewed, KF Advisors cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided. KF Advisors represents two investment advisers registered with the Securities and Exchange Commission: Klingenstein, Fields & Co., L.P. and KF Group, LP. If you are a KF Advisors client, please remember that it remains your responsibility to advise KF Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.