Diversification Works When Done Correctly

At Alitis, we spend a lot of time reading and learning about the financial markets. We stay up-to-date on current events, we constantly monitor our positions, and we are always keeping an eye out for new investments that could improve our portfolios and their diversification.

That being said, we do understand that the financial marketplace can be a complex and confusing place, and there are some common pitfalls that we need to be mindful of. One of those pitfalls is called naive diversification.

Naive Diversification

Naive diversification occurs when someone has bought many different investments that they incorrectly believe to have the benefits of having either a low or negative correlation. They hope that they are protected from having large losses across their portfolio at the same time, but unfortunately, they are not.

An example would be someone that has “diversified” their portfolio by buying all the bank stocks in Canada. This is better than putting all of one’s money into only one bank stock, but there are plenty of factors that would affect all Canadian bank stocks at the same time. The same could be true of a portfolio containing all stocks in the world, as stock markets globally have similar exposures and are highly connected.

Imagine having a closet full of different shoes, but they are all high heels. You have hundreds of pairs of high heels, full of colourful designs, patterns and fabrics, but only high heels. If we asked you, “Do you have many pairs of shoes?” your reply would be, “Of course! I have hundreds of pairs!”

We would think that you must be well-prepared for all occasions with so many shoes. However, the next time you go to buy groceries after it snows, or you go to mow the lawn, or you go on vacation to Europe and have to walk down a cobblestone street, you may be surprisingly ill-equipped.

Our Approach to Diversification

At Alitis, we take a great deal of time and effort to ensure that your portfolios are both well-dressed and well-suited for a variety of market conditions. We select investments with purpose and keep in mind how new investments will complement the rest of the portfolio. After all, how your entire portfolio performs is more important to us than any single investment.

We look to create meaningful diversification across many asset classes and markets with the goal of providing a stronger risk-adjusted return than our benchmarks. And we are proud of that.