The notion of diversification in investing is often met with a mix of curiosity and skepticism. Some view it as a necessary evil, while others see it as a way to avoid taking risks. As an investment strategist, I’ve found myself repeatedly answering the question of how to make money in the stock market, and my response is always the same: diversify. At parties or social gatherings, I often find myself explaining the importance of diversification to those who are eager to get in on the next hot stock. However, my responses are met with a mix of disappointment and frustration. It seems that many people are looking for a magic bullet or a surefire way to make money in the market, rather than taking a long-term approach. In the aftermath of the credit crisis, diversification was put to the test. Portfolios that were traditionally considered diversified were unable to withstand the global reach of the crisis, and protections failed when they were needed most. The past decade has proven that simply adding foreign investments to a portfolio does not equal diversification. More recently, diversified portfolios have fallen behind, and it’s easy to see why. So, why do I always say diversify? As we know, markets are cyclical, and we are currently in a very uncertain cycle. Diversification benefits diversified investment portfolios in this environment. While it’s true that a highly concentrated portfolio can benefit in times of strong earnings, clear policies, and stable global relations, that’s not the case now. Investors are faced with a full list of uncertainties, and a diversified portfolio can help you navigate these challenges. While diversification might be holding your portfolio back in certain situations, it can also help you gain exposure to top-performing investments that you might otherwise miss. For example, foreign equities have proven to be a valuable addition to a diversified portfolio. According to Figure 1, the S&P 500 index outperformed the MSCI World ex USA index by a cumulative 158.80% over the past 10 years. However, this performance has shifted in recent months. During the first six months of this year, the MSCI World ex USA index outperformed the S&P 500 index by 13.26% (Figure 2). Shifts in market sentiment and performance can happen quickly, and you’ll likely miss the early stages of the rotation if you try to time the market. Normalization will benefit diversification. After years of aggressive and historical monetary and fiscal policies, investors often forget what “normal” is. 1% on 10-Year Treasury yields are not normal, nor are interest rates at zero or a ballooning Federal Reserve balance sheet. These abnormalities distorted markets, as investors were flush with “free” cash to spend or invest. This cheap money artificially propped up asset prices and inflation, which resulted in an increase in asset-class correlations. However, as inflation approaches the Fed’s target, asset-class correlations are expected to decrease, and diversification will benefit from this normalization. The relationship between 10-year Treasuries and equities is also worth noting. Over the past 30 years, the two have had an inverse relationship, with a correlation of -0.10. However, this relationship breaks down during times of increased inflation. As inflation has been stubborn recently, it’s within shouting distance of the Fed’s target, which is good news for diversification. Since 2009, there have been long periods of time when the 10-year Treasury yield was below 2%. However, the 40-year average yield on 10-year Treasuries is 4.74%, while the 20-year average yield is 2.91%. At the time of this writing, yields are at 4.38%, which is within the normal long-term range for real yields. Diversification can be boring, especially when someone is searching for the next 10-banger. However, a sound diversified investment portfolio can help you hedge against being wrong, and it’s a strategy that will benefit you in the long run. Normalizing inflation, along with a smaller Fed balance sheet and normalized interest rates, will help bring diversification back from the dead. At Zephyr, we offer portfolio construction, proposal generation, advanced analytics, asset allocation, manager screening, risk analysis, portfolio performance, and more. Our goal is to help investment professionals make more informed investment decisions on behalf of their clients. As the Market Strategist at Zephyr, I can attest to the importance of diversification in creating a well-rounded investment portfolio.

In conclusion, diversification is an underappreciated investment strategy that can benefit investors in the long run. While it may not be the most exciting strategy, it’s a crucial component of a well-rounded investment portfolio. By understanding the importance of diversification and normalizing inflation, interest rates, and asset-class correlations, investors can create a diversified portfolio that will help them navigate the challenges of the current market cycle. Disclaimer:

As a market strategist, I always emphasize the importance of diversification, but I also want to make it clear that this is not a guarantee of returns or a promise of success. Investing always involves risk, and there are no guarantees that diversification will work for every investor. However, by following a diversified investment strategy, investors can reduce their risk and increase their potential for long-term success.