I recently read the December’s Investment Advisor magazine and found most investment advisors were touting their use of diversification to reduce the risk of their client accounts. Do people really buy into this rhetoric?

The issue was filled with articles and pretty pie charts explaining the benefits of diversification until the very last page where the article, “The Failure of Asset Allocation” appears. This article reveals the truth: Having a diversified portfolio has not protected investors from this bear market.

With the exception of U.S. Treasury Bonds, all major asset classes have lost value in 2008. Equity REITs and REIT mortgages were supposed to be a diversifier, but they are down 37% plus. Foreign stocks and emerging markets were supposed to diversify away some of the equity market risk exposure, but they are down 46-56% respectively. TIPs and high yield bonds were supposed to help “diversify” fixed income allocations, yet relative to plain garden variety intermediate government bonds they have underperformed by 18-27% respectively. Commodities were another “asset class” tossed into the theoretical diversification bucket, but they are down 26%.

Holding all of these asset classes was supposed to protect client assets by lowering portfolio risk. It didn’t, and it won’t. As the market recovers, the securities will become uncorrelated once again placing a drag on portfolios.

I prefer to place bigger bets on individual areas and as I perform research for a follow-up on ETF trading, I’m finding it pays to run our rotation model on the asset classes, making sure to include both long and short choices, to see where portfolios should be concentrated. By including securities such as long dollar and short dollar, we can be sure that there truly is “always a bull market somewhere.”

David Vomund
http://www.etfportfolios.net/