Does diversification still make sense for U.S. investors?

Although there are countless strategies, theories and approaches to investing, there is one concept that nearly everyone tends to agree on: The value of diversification.

Simply put, diversification is rooted in the notion that you do not want to “put all your eggs in one basket”—because what if that one basket fails. When it comes to investing, this means that a multi-asset portfolio—made up of a variety of asset classes—is typically less risky and may have higher returns over longer time periods, than a portfolio that is concentrated in one individual area of the market.

Diversification sounds great—but isn’t always easy to stick to

Sound as the theory appears, it’s not always easy to stick to the strategy. Case in point: many U.S. investors have questioned the value of owning anything other than U.S. stocks as they’ve watched the U.S. stock market (Russell 3000® Index) repeatedly reach new record highs over the last few years and beat all other major asset classes. If your experience and view is like the chart below, then diversification seems like a losing strategy.

Source: Russell, Barclays, Bloomberg, MSCI and FTSE NAREIT.

U.S. Equity—Russell 3000® Index; Non-U.S. Developed Equity—MSCI EAFE; Emerging Markets—MSCI Emerging Markets; U.S. Bonds—Bloomberg Barclays U.S. Aggregate Bond Index; Global real estate—FTSE EPRA/NAREIT Developed Index; Commodities—Bloomberg Commodity Index.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Nothing lasts forever

The key is to assess the data from various angles. One cut of the data—in this case, annualized returns—doesn’t tell the whole story. Calendar-year returns lead to a different conclusion, as the chart below illustrates.

As of September 2017. Source: Russell, Barclays Bloomberg, MSCI, FTSE, Bank of America/Merrill Lynch, S&P.

U.S. equities—Russell 3000® Index; International Developed equities—MSCI EAFE; Emerging Markets: MSCI Emerging Markets; U.S. Bonds—Bloomberg Barclays U.S. Aggregate Bond Index; Global high yield—Bank of America/Merrill Lynch Global High Yield Index; Global real estate—FTSE EPRA/NAREIT Developed Index; Commodities—Bloomberg Commodity Index; Global infrastructure—S&P Global Infrastructure Index.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

This chart offers a slight twist on the classic quilt chart of asset class performance. Rather than stack-ranking asset class performance for a given calendar year relative to zero, this chart illustrates the returns of various asset classes relative to the U.S. equity market (highlighted in the center of the chart). So, any asset class that appears above U.S equity outperformed for that calendar year, while any asset class that appears below U.S. equity underperformed for the calendar year.

This chart also helps remind investors that it wasn’t that long ago when U.S. equity was not a very popular place to invest. From 2000–2007, U.S. equities consistently trailed most other asset classes. U.S. equities experienced a particularly rough patch from 2002–2006, underperforming International Developed Equities, Emerging Markets Equities, Global Real Estate and Global Infrastructure in every calendar year. This underperformance has caused many people to refer to 2000–2009 as the “Lost Decade” for U.S. equity investment returns. Diversified investors were rewarded, though, as other asset classes earned positive returns in this time period, with some asset classes more than doubling in value, as the table below shows.

Emerging Markets Equity: MSCI Emerging Markets; Global real estate—FTSE EPRA/NAREIT Developed Index; Commodities—Bloomberg Commodity Index; Global high yield—Bank of America/Merrill Lynch Global High Yield Index; U.S. Bonds—Bloomberg Barclays U.S. Aggregate Bond Index; International Developed Equity—MSCI EAFE; U.S. Equity—Russell 3000® Index; Global infrastructure—S&P Global Infrastructure Index.Source: MSCI, FTSE, Bloomberg, Bank of America/Merrill Lynch, Russell, S&P.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

Diversification outlook

At the end of the “Lost Decade,” it would have been tempting to reduce or even eliminate U.S. equities from portfolios based on their track record over the previous 10 years. However, that decision would have been costly over the next few years. Similarly, many investors who chose to reduce non-U.S. equity allocations have suffered so far in 2017. Despite strong returns of 14% for U.S. equities year to date as of September 2017, they have trailed Emerging Markets equities, International Developed equities and Global Infrastructure which have gained 28%, 20%, and 17%, respectively. So, the theory of diversification still holds: not a single asset class can consistently outperform; market leadership rotates in unpredictable cycles among asset classes.

The bottom line

A globally diversified multi-asset portfolio is designed to help investors avoid the common pitfall of chasing recent returns and moving into or out of an asset class at exactly the wrong time. Market leadership can change abruptly and when it does, diversification—even though it doesn’t assure a profit or protect against loss in declining markets—remains one of the best ways to manage through market swings.

Disclosures:

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

Standard & Poor’s Corporation is the owner of the trademarks, service marks, and copyrights related to its indexes. Indexes are unmanaged and cannot be invested in directly.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Russell 3000® Index: Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index: A float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

Bloomberg Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. (specifically: Barclays Government/Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).

Bloomberg Commodity Index Total Return: Composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as “rolling” a futures position.

FTSE EPRA/NAREIT Developed Index: A global market capitalization weighted index composed of listed real estate securities in the North American, European and Asian real estate markets.

BofA Merrill Lynch Global High Yield Index: Tracks the performance of USD, CAD, GBP and EUR denominated below investment grade corporate debt publicly issued in the major domestic or Eurobond markets.

The S&P Global Infrastructure Index: Provides liquid and tradable exposure to 75 companies from around the world that represent the listed infrastructure universe. To create diversified exposure across the global listed infrastructure market, the index has balanced weights across three distinct infrastructure clusters: Utilities, Transportation, and Energy.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

The Russell logo is a trademark and service mark of Russell Investments.

Copyright © Russell Investments Group, LLC 2017. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

Russell Investments Financial Services, LLC, member FINRA (www.finra.org), part of Russell Investments.

RIFIS: 19421

  1. No comments yet.

Millennials are the future.
Engage them now.

Millennial InvestorSubscribe to the Helping Advisors Blog and receive a free copy of the Millennial Investor.

We will only use your email for Helping Advisors Blog updates.