What do football coaches and Warren Buffett have in common? The supposedly banal knowledge that only the right mix of individual talents makes up a powerful unit. For coaches, it might just be a matter of the hands on deck, but for investors it is about experience – which is also underpinned by academic studies. These continue to underscore the paramount importance of diversification for an investment to succeed. The topic is also of prime importance at Werthstein. Let’s go back to the basics.
A spread means diversification in financial speak, when defensive elements are mixed with offensive elements in such a way that they complement each other. For example, if shares lose value of the course of a year, then bonds will continue to yield interest regardless and will subsequently act as a shock absorber for your portfolio. This mechanism even works at times of low interest rates even if the displacement is shorter than at times of higher prime interest rates, for example. The same idea also works in asset classes. For example, US equities losing value does not necessarily mean a drop in price for European markets. Have you taken a closer look?
For example, equities can look good with a value approach, while high-growth securities suffer. The reverse is also true. For example, if tech shares, with their daring vision for a bright future, lose value, then the “flight to quality” often arises, i.e. the escape to quality shares. It is these supposedly boring shares that are frowned upon in the exciting stock market phases. A good investor knows about these developments and makes provisions by mixing securities with these different properties. This is just like a football coach adding nimbly-footed players and born fighters, natural defenders and carefully selected strikers to a team. This is when science comes into play.
Character test for the portfolio
Numerous studies claim that around 80 percent of a portfolio’s performance is made up the composition of the team in the portfolio. Some even assume an even more powerful influence. US professors Gary Brinson, Randolph Hood and Gilbert Beebower, for example, place 100 percent of the impact of this mixture on investment success. What is it like in practice? Star investors such as David Swensen, who has been in charge of the Yale Foundation since 1985, have been extremely successful thanks to a broad diversification across various asset classes such as equities from different regions or bonds. Just as with a well-composed football team and in the Werthstein base portfolio.
That is where both American and European stocks are firmly found in the list, for example. This is in contrast to bonds. Both investment classes could be mapped using two ETFs; one for stocks and one for bonds – a strategy that does not offer points in terms of diversification. This is because more and more specialized ETFs allow a broader spread across countries and currencies. This is especially the case when they are constantly being rebalanced so that they can always be adapted to the challenges of the environment.
The US, for example, is the world’s largest economy with a gross domestic product of $ 18.595 trillion. And even better: According to the World Economic Forum’s Global Competitiveness Index, America is the second most competitive country in the world, amongst no less than 137. This means ever newer business ideas, ever newer products and maybe even a new Amazon. Also, the same idea leads to Germany finding its place in the Werthstein base portfolio. The automotive industry is amongst one of the most competitive in the world, for example.
The bond ETF is positioned defensively in the base portfolio. At Werthstein, we rely on high-quality bonds without currency risks. It is easier to write about them than to find them in view of the low interest rates. Therefore, German covered bonds and European corporate loans have found their way onto the starting list. This is in addition to government bonds from around the world – with ETF, of course, hedging currency risks. Keep tight at the back and score points at the front.