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