Is Your Portfolio Truly Diversified?

Investing 101 teaches us that portfolios should include a variety of diverse assets in order to help protect from downside risk and lower volatility. Frequently, investors are instructed to include a mix of US equities, foreign equities (both emerging and developed markets), investment grade bonds, and high yield bonds in their portfolios. However, the effectiveness of this diversification strategy varies, depending on the correlation among constituent assets.

Diversified Portfolio

Simply put, correlation is the extent to which assets perform in relation to one another. If assets in an investor’s portfolio are highly correlated, that investor is either hitting it out of the park or dragging their bat back to the car in the parking lot. Alternatively, low correlations among assets in a portfolio can help to reduce market volatility and boost the outlook for risk-adjusted returns.

What makes this tricky? Correlations between assets can change over time.  For example, Pfizer (NYSE: PFE) and Amazon (NASDAQ: AMZN) had a 0.13 correlation from 2001 through 2005, and a 0.16 correlation during 2016, but a 0.43 correlation from 2008 to 2009.¹ Correlations are measured from -1 (whereby performance moves in opposite directions) to 1 (returns move in the same direction). In times of market stress, asset correlations tend to rise, as shown in the example above.

In 2011, seemingly diverse financial assets were moving in lockstep. In the time since, that correlation has somewhat subsided, but there are numerous macroeconomic factors that would suggest that, on average, assets may be more highly correlated than they were 20 years ago.

Food for thought:

  • Globalization and the internet allow investors to play in multiple markets and react almost instantaneously to communications received at approximately the same time around the world. It is also easier to invest globally than it ever has been before, especially as multinational corporations have larger operations in many countries and goods are assembled across borders.
  • Broad economic shocks overwhelm company and industry-specific developments, causing investors to take on a risk-on vs. risk-off mentality. When macroeconomic worries are high, investors tend to flee high risk investments and flock towards lower risk investments, and in turn, when macroeconomic worries are low, the opposite happens. For example, the Brexit vote affected more than just Great Britain and Europe; the surprise vote to leave the EU had effects on financial assets globally.
  • Widespread use of index products and ETFs allow investors to increase or decrease their exposure to an asset class or sector more easily than other forms of trading. By selling shares of the S&P 500 index, investors are selling shares of 500 companies across a variety of industries all at once, rather than just a handful of targeted stocks.

Alternative assets, such as real estate, can provide a core risk management tool for investors due to the sector’s low or negative correlation with stocks and bonds. Real estate is less liquid than most financial assets, which contributes to its valuation moving more slowly and with less volatility when compared to stocks and bonds. As such, it is common for private real estate properties and portfolios to be valued on a quarterly basis. Investors in such offerings seek to avoid the often unpredictable day-to-day fluctuations of exchange traded assets, while potentially keeping correlations low. Private portfolios of real property have the potential to offer investors diversification in a number of ways, including by geography, size, lease term, tenant (or brand), lease type, etc.

Broadstone Real Estate (Broadstone) sponsors two such open-ended alternative investment offerings—Broadstone Net Lease (BNL), a diversified, net lease commercial REIT focused on acquiring freestanding, single-tenant properties, and Broadtree Residential (BTR), a residential income REIT that acquires multifamily apartment communities. Both REITs offer accredited investors an income-oriented alternative to the exchange-traded equity markets, dividend yield, and the potential for share price appreciation. An investor’s allocation of assets to a fund such as BNL or BTR can help to shield an investor from some daily market volatility and can be used as a tool for estate and succession planning.

To learn more about investment opportunities with BNL and BTR we invite accredited investors, advisors, and institutions to download an investor kit.

¹Source: https://www.portfoliovisualizer.com/asset-correlations

This blog post is for informational purposes only and should not be construed as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.

Originally published February 9, 2017, updated December 12, 2018

About The Author

Danner Hickman
Vice President, Research & Analysis
Danner Hickman joined Broadstone in August 2014 and serves as Vice President, Research. She is responsible for conducting market, industry, and competitive research for Broadstone and its family of investment offerings, and utilizes her background in finance to assist in the company’s debt capital markets activities. Danner analyzes the effects of real estate and macroeconomic trends on the company’s strategy and performance and also plays an active role in product development and special projects.