Portfolio Diversification Part II

The previous article explained Portfolio Diversification and made an attempt at showing the benefits using only two different mutual funds. This article will explore some additional ways to improve portfolio diversification.

Use More Assets

One way to improve portfolio performance is to use more assets or to try to get assets that don’t correlate highly with each other. Three different portfolios are tested below from 1995 through January 2019. These portfolios are as follows:

  1. Portfolio 1 is the 60% US stock40% US bonds looked at in the previous article.
  2. Portfolio 2 contains additional assets, including those not expected to correlate highly with one another.
  3. Portfolio 3 is the Harry Browne Permanent Portfolio discussed here.

The content of each portfolio and its weighting is shown below. Each portfolio was rebalanced each year.

Three Portfolios

(Click on image to enlarge)

Portfolio 2 contained 11 assets. The first three represent classes of US stocks (30%). The next three represent International stocks (20%). Then there are two categories of traditional US bonds (20%) and some “Junk” bonds (5%). The last two are REITs (5%) and Gold (10%). Both these should have low correlation to stocks.

Portfolio 3 is the Permanent Portfolio of Harry Browne.

The latter two portfolios are different and were expected to produce better diversification results. Here are the results:

(Click on image to enlarge)


Comments on Results

Portfolio 2, with more assets and lower correlated ones, underperformed Portfolio 1 (the two asset 60 – 40 split) on both return and drawdown. It provided protection for the first market debacle (2001) but not the second (2008). Portfolio 3 performed as designed showing slow, low volatile growth over the entire period. Its drawdown was only 13% versus the other two which were in the thirties. The market benchmark of all stocks suffered a drawdown of 50%.

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