PORTFOLIO DIVERSIFICATION – DOES IT STILL WORK?
If you have over five years’ experience as an investor, you probably embrace the premise that portfolio diversification is important to long-term investment success. This premise is based on the historical experience that markets move in cycles, and certain asset classes will outperform others in different cycles. Given this year’s wild swings in the markets, and minute-by-minute reporting by the media, of investor interest rate and earning concerns, it has been easy to question the wisdom of market diversification. It may be helpful, therefore, in determining a portfolio strategy for 2001 to review which asset classes have been the winners and losers over the last 12 years.
Following is a list of the accepted classes and relevant indices:
International: MSCI EAFE – Morgan Stanley Capital International, Europe, Australia, and Far East.
Large Cap Growth: Securities in the Russell 1000 Index with a greater-than-average growth orientation.
Mid Cap: Smallest of the 800 capitalized securities in the Russell 1000.
Large Cap Value: Securities in the Russell 1000 Index with a less-than-average growth orientation.
Small Cap: The smallest 2,000 companies in the Russell 3000 Index.
S&P 500: Currently comprised of 400 industrial, 20 transportation, 40 utility and 40 financial companies.
The chart at the bottom of this page shows a listing of winners and losers over the past 12 years. The variation in the spread of returns between the winners and losers has been from 10.10 percent in 1994 to 41.3 percent in 1998. Performance among the different asset classes varies from year to year. This chart shows why diversifying among different asset classes is important to long-term success. Over the short-term, this year’s winner may be next year’s loser.
Portfolio diversification among asset classes is an integral aspect of risk management. Because markets historically move in cycles, with some asset classes outperforming others, diversification is imperative to any sound investment strategy.
