Investment diversification may not help in the next global recession. Diversifying among asset classes will simply be diversifying your losses.
The entire world is getting ready to enter a period that I call the “Great Reset.” It is a period of enormous and unpredictable volatility in all asset classes. What do we do?
I think that the answer lies in diversifying among trading strategies that are not correlated to each other. And using managers who have a mandate to invest in any asset class their models tell them to.
Active management will make a difference
The theory behind active management is that managers can make a difference by using their superior analysis and systems. They then put only the best stocks in their portfolios. And they might even short the bad ones.
The manager’s edge is the ability to decide which companies have positive profit performance and which have problems.
If you were particularly good, from the 1980s and through the first decade of the 2000s, you created a “long-short hedge fund.” This is where you went “long” the stocks you thought were the better ones. And you would “short” those you thought would fall in value.
There were many different ways to do this. But they all depended on a manager that had an “edge”—some insight into the true value of stocks.
But in the past few years, that edge seems to have gone away. Money has been flying out of many of these funds. And not just the long-short funds.
Active managers in the long-only space have been doing just as badly as their hedge fund brethren. Only about 10% of large-company mutual funds did better than the Vanguard 500 Index Fund in the last five years.
Not surprisingly, a growing number of asset managers actively trade ETFs using their own proprietary systems. Globally, there is about $3.8 trillion in ETFs today. There are almost 2,000 ETFs in the US alone. And according to ETFGI, there are 4,874 ETFs globally. Assets in ETFs have shot up from $807 billion in 2007 to $4 trillion today.
No matter what asset you want, there’s now an ETF for it.
Use multiple asset managers with different styles
I use four active ETF asset managers/traders. Each has a very different style. That approach likely gives me much less volatility than each manager’s system would face by itself.
Part of my edge is that I have been in the “manager of managers” business for more than 25 years. I have looked at hundreds of investment managers and strategies. That has actually been my day job when I’m not writing.
So when a manager explains his system to me, I can “see” how it fits with those of other managers. I can grasp if it is truly different from the others. And I can decide if it would add any benefit to my total mix.
I’ve also learned that having more than four managers does not improve overall performance. It merely makes it more complex and expensive.
I believe passive investment strategies will come under severe pressure in the coming years. Many investors have their “core” portfolios in these passive strategies.
If you are prepared to ride out another 2001–2002 or 2008–2009 and then go through what I think will be an even longer and weaker recovery (until the debt issue is resolved), then stick with your passive strategies.
But there are other options that can see you through.
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