- The traditional wisdom has it that investors should "diversify" their portfolios.
- On the surface, that makes perfect sense. But when you start to dig into the concept, there are some serious flaws.
- Diversification comes form the idea of not putting all your eggs into one basket.
- But, is that solid advice for the average investor? I don't think so.
The concept of "diversification" is very interesting to me, on many different levels.
When it comes to investment portfolios, "diversification" usually means a basket of domestic stocks, bonds, short term investments, and international stocks.
Now if you are a committed "diversification" investor you can add sector funds, commodity focused funds, real estate funds, and asset allocation funds to your investment portfolio.
There is, what seems to be, an infinite number of "diversification" categories to fill each and every need that an investor may identify as something of value, but in the end "diversification" leads to underperformance just based on the simple concept of math.
Take a "diversified" stock market index like the S&P 500 Index (SPY).
How does it get any better than owning 500 individual stocks, all in one investment? Count them.
But that Index has limits to its performance.
Reality Is A Bitch:
When you consider owning (SPY), you might think that you own 500 companies in equal weighted share counts. But you would be wrong.
Let's look at the "Top 10" holdings in (SPY):
The (SPY) currently has 10 companies that represent 26.7% of the stock allocation of the Index. Wait. What?
But the "diversification" gets even worse. Take for example, a look at the allocation by stock sectors, in the Index:
What is troubling here, is that some of the best performing sectors, over the last 3 months have little representation in the Index.
Asset Allocation and Performance:
Energy has been the best performing sector in the S&P 500 with a gain of 41.2% and yet, the Index only allocates 2.3% of assets to this sector.
Financials are up 23.5% over the last 3 months and yet, the Index only allocates 10.5% of assets to this sector.
Materials are up 18.6% and the Index allocates 2.6% of assets to this sector.
Industrials are up 13.4%, but the Index allocates 8.4% of assets to that sector.
Wow. That's an eye opener.
But Wait, Let's Look At This:
Information Technology has the largest allocation of assets with 27.6%, but the sector is only up 5.8%.
Health Care has 13.5% of assets, but is only up 7.9%.
Consumer Discretionary has 12.7% of assets and is up only 6.9%.
Communication Services hold 10.8% of assets, but is up only .5%.
Let's Compare Winners and Losers:
There are 4 sectors with the largest allocation of assets and those 4 sectors represent 64.6% of the assets in (SPY).
Of these 4 sectors, the best performer is Health Care and that's only up 7.9%.
But there is another group of 4 sectors represent only 23.8% of assets.
The best performer in this group of 4 is Energy, which is up 41.2%.
The end result of the "diversification" in the (SPY?)
A Look At Energy:
There are 24 Energy companies in the S&P 500.
Only 24. Not all of them are Dividend Champions, Dividend Contenders, or Dividend Challengers. But over the last 3 months, the group has performed better than any other stock category.
You tell me. I have my own idea as to why, but let's see what you think.
|Stock||Company||Price||Current||5 Year Ave||3 Month|
|OXY||Occidental Petroleum Corp||$23.07||0.18%||5.09%||129.10%|
|DVN||Devon Energy Corp||$20.00||2.25%||1.44%||122.97%|
|FANG||Diamondback Energy Inc||$60.02||2.53%||0.23%||110.97%|
|MRO||Marathon Oil Corp||$8.57||1.45%||2.12%||106.51%|
|BKR||Baker Hughes Co||$22.87||3.15%||2.17%||67.79%|
|EOG||EOG Resources Inc||$60.48||2.53%||0.89%||66.70%|
|PXD||Pioneer Natural Resources Co||$132.04||1.73%||0.24%||58.07%|
|MPC||Marathon Petroleum Corp||$46.09||5.28%||2.77%||57.63%|
|VLO||Valero Energy Corp||$60.54||6.72%||3.42%||48.75%|
|XOM||Exxon Mobil Corp||$48.84||7.27%||4.06%||44.93%|
|KMI||Kinder Morgan Inc||$15.55||6.78%||5.46%||22.63%|
|WMB||Williams Companies Inc||$22.45||7.11%||6.29%||14.02%|
|COG||Cabot Oil & Gas Corp||$18.61||2.10%||0.90%||-3.42%|
In 3 months.
Is Mediocrity A Recurring Theme With Diversification?
One could argue that in order to fully grasp the concept of diversification, one needs to be invested in domestic stocks, bonds, fixed income vehicles, and international stocks.
But performance within each of these categories can be all over the place. And the performance of each investment and the amount of money you've allocated to each investment will affect your investment performance.
Not long ago, I wrote a blog about investing during the pandemic. These two articles came from a book that was written by Napoleon Hill, "Think And Grow Rich."
So, I decided to take a break, just to consider things and what was going on in the world. I came to the unmistakable conclusion that the Pandemic was presenting me with opportunities where I could invest my money and make that investment grow.
Here are links to the Pandemic articles:
Shifting to a strategy of owning these companies and investing aggressively in them has proven to be a great move.
The companies we bought are largely hated by most investors on Seeking Alpha. They are hated because these stocks don't always pass the muster of sound "financial analysis" that investors tend to use. You know like Price to Earnings, Price to Book Value, etc.
But it seems that the market, as we've been saying, is not your father's stock market, but something different and new.
For the future? Focus on Financials, Industrials, and Materials as "buy" categories.
Enjoy. Make money. Live live large.
Analyst's Disclosure: I am/we are long CVX, XOM, COP, MPC, PSX, VLO.
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