Diversification starts with the question of where the risk comes from
The point of diversification is to limit how much the whole estate depends on one source of return and one type of risk.
If a significant part of the portfolio is tied to the same market, sector, currency or economic scenario, in some situations it can start behaving very similarly, no matter how many individual investments it holds.
So when a portfolio is being built, counting funds, ETFs or individual positions is not enough. What matters is understanding what actually sits underneath them.
An investor may own several different global and US equity funds. At first sight these are different products from different managers. Looking inside, they may find that a significant part of each one consists of the same large American companies.
The number of investments grows. Real diversification grows considerably less.
What this looks like in practice is described in a model story of a client who held seven funds from three advisors and only after comparing them found that part of the investments overlapped.
Five accounts do not mean five different strategies
We see a similar situation with clients who have invested gradually in several places.
Part of the capital sits with a bank, more of it goes through an investment platform, something else is with another securities dealer, and alongside that there are a few investments that arose over the years out of individual opportunities.
Every one of those decisions may have made sense at the time. Gradually, though, a structure can emerge in which it becomes harder and harder to answer a simple question: how is my wealth actually invested as a whole?
Having capital spread between a bank, an investment platform, a securities dealer and another manager can mean diversification of providers. On its own it does not mean diversification of investments. If similar assets, regions or strategies repeat under the individual accounts, the investment risk stays concentrated.
There is also a second problem: a loss of overview. The investor follows several statements, different reporting methods and separate results, but loses sight of the whole. It is then harder to see not only the real level of risk, but also where investments overlap needlessly and what role each part of the wealth is meant to play.
Good diversification has several layers
With larger wealth it therefore makes sense to think about diversification on several levels at once.
The first one is asset classes. Equities, bonds, cash instruments, property or alternative investments respond to the economy differently and can serve different functions in a portfolio.
The next layer is regions and sectors. A global portfolio limits dependence on one economy, and a sensible sector spread reduces concentration in a few industries.
Currencies, liquidity and the investment horizon matter as well. Part of the capital may need to be available at relatively short notice, while another part can work for ten or twenty years. Its structure should reflect that.
Wealth spread across several countries adds a layer of its own. Alongside asset classes and regions, what matters there is the currency of future spending and whether the setup would survive a change of country, which is the subject of a separate article on investing in the Czech Republic as an expat.
And with larger portfolios a combination of different investment approaches and managers can matter too. Even here the goal is not their number. What matters is that each of them brings something to the overall structure that is genuinely missing from it.
Diversification is not collecting investments
As wealth grows, so does the number of options. New funds, private markets, property projects or individual investment opportunities come along.
That is exactly when it is important to make sure diversification does not gradually turn into a mere collection of investments.
Every new position should have a clear reason to be in the portfolio. It should complement the existing structure, match the investment horizon and offer a balance of expected return and risk that makes sense for the estate as a whole.
So sometimes better diversification means adding a new asset. Other times we find that a portfolio contains several different routes to the same outcome and needs simplifying instead.
One portfolio, one view of the whole estate
That overall view is what we consider essential in managing larger wealth.
A client may use several banks, investment companies or managers and still have a clearly defined strategy. But they need to know how the individual parts fit together, where risks overlap and what function each investment serves in the whole.
At Melior Invest we therefore do not look only at individual products when building and managing a portfolio. We watch the structure of the estate as a whole: the weight of each asset class, region, sector, currency, investment horizon and source of risk.
That lets us adjust the portfolio continuously so that its individual parts work together according to the client’s long-term strategy.
A well diversified portfolio does not need the most positions or the most accounts. What it needs above all is a clear structure in which the investor understands what they own, why they own it and how the individual parts of their wealth work together.
Would you like to know whether your investments make sense as a whole? We would be glad to meet.
