Diversification Performance Through the Panic

If you have been following financial markets, even casually since February, you would know that we are in the midst of one of the fastest and sharpest equity market drawdowns in history. Although it may feel like the financial world is on the brink of collapse, a recent article by Ben Carlson of A Wealth of Common Sense reframes the discussion to focus on long-termism. While short-term performance may feel catastrophic, it is still nowhere close to complete ruin. Depending on portfolio allocation, returns as far back as five years may have been erased, but permanent loss of capital is unlikely. When introducing the concept of diversification into the mix, things start to look even better. Prior to the most recent drawdown, equity-centric portfolios have outperformed balanced mandates over the last 10 years, and it is easy to see why many would feel an allocation to perceived safe assets (such as fixed income) would only serve as a drag on performance. However, when you incorporate a period of severe drawdown into the sample (like the last month), those portfolios with diversified allocations outperform their concentrated counterparts by a healthy margin. This serves to illustrate the power of diversification – it seems useless until it is not.