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Diversification – What Happened?

We’ve heard it time and again – “Don’t keep all your eggs in one basket.”  This childhood lesson finds its way into most investment portfolios, with diversification being an important and well-accepted principle in developing a long-term strategy with the opportunity for steady growth.

Knowing the benefits, it is all the more painful to see a situation in which diversification creates a moment-in-time significant underperformance.  So far in 2020, the single asset class of U.S. large growth companies, specifically led by technology stocks, are producing outsized returns compared to every other asset class – and by a long shot.

As an example, year-to-date returns through August 7th for the largest 1000 U.S. companies  (Russell 1000) are +21% for growth companies and -11% for value companies.  Take a moment to think about that that difference.  Indexes of smaller U.S. companies, emerging markets, and developed countries ex U.S, were also all significantly lagging large U.S. growth companies. When we hear of the rebound of the stock market, we should remember that much of that rebound is generated by a handful of well known large technology stocks.

We have all seen the dominance of some technology stocks over the recent past and for good reason.  The value creation of technology is undeniable.  But in reviewing the returns of each of the most recent ten years, there is nothing comparable to the 2020 year-to-date outsized returns generated by large growth companies vs. every other asset class of stocks.

This brings us to a few observations:

  • We are in a unique moment. The global pandemic has dramatically dampened the earnings and the returns of most industries around the world. Technology companies have so far been less susceptible to the negative earnings disruptions caused by the virus.
  • We cannot predict which asset class will produce the best returns in any year. One look at the relative ranking of various asset classes, year to year for a 20 year period, tells us clearly that there has been no consistency or pattern to which asset class was the outperformer in any year.  That includes the past 5 years in which the technology stocks have become increasingly popular.  The chart at the top of this post supports this point.
  • Every day is one day closer to a vaccine. At that point, it is reasonable to assume that businesses may accelerate their recovery and/or adjust to the world post-Covid.  Headwinds from Covid should recede, bringing the return of positive dynamics of diversification.

Diversification remains important for a successful long-term investment strategy. Don’t let this current market lead you to believe otherwise.

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