Diversification

Investment management is all about optimizing the unique nature and expected performance of competing securities and asset classes (PDF) in an effort to maximize your portfolio's potential return given your risk tolerance, time horizon and other constraints. Diversification plays a key role in portfolio design, both in terms of risk management, but also in expanding the investment opportunity-set.

Risk can be quantified statistically as standard deviation. While there may be multiple sources, generally market and security-specific risks are the focus of investors. In addition to disciplined security selection, diversification across asset classes, investment management styles (PDF) and underlying money management has proven effective at controlling (moderating) risk and volatility.

It is the differences which make all the difference...

Statistically, a blend (PDF) of securities or asset classes which are less than perfectly correlated will result in lower overall portfolio risk, and as a result likely enjoy correspondingly lesser price variability. The distinctiveness of individual investments suggests that the overall risk of a portfolio can be effectively reduced by simply adding to the number of securities within; even when securities are selected without regard to their specific risk and return characteristics.

Engineering an "Efficient" Portfolio Solution

While the adage of "not all your eggs in a single basket" is as valid today as ever before, a sum of the parts perspective will always be overshadowed by a more highly coordinated portfolio management effort. In portfolio terms, the ideal of constructing a truly efficient portfolio (PDF); that is one which provides for the highest expected rate of return for a given level of risk, can be supported mathematically by the notion that while near term performance results appear to be completely random, returns over the long run are in fact predictable... as illustrated by plotting the investment returns of the modern era (1925 to present) under the bell-curve (PDF). Because long-run returns are normally distributed (PDF), predictions can be made made about how portfolios will behave, and these insights can then be applied in optimization.

Pension Approach – Multi-Asset Class, Multi-Style, Multi-Manager

Both from a risk control perspective and also when considering Canada's more limited footprint in terms of home market capitalization as compared to global markets, a more irons in the fire approach may be beneficial. Consistent with many institutional, pension-like (PDF) portfolio solutions, a multi-asset class, multi-style, multi-manager (PDF) design may serve to help control day-to-day price variability while achieving often more consistent, predictable returns.