In this installment, we will provide a more detailed explanation of true diversification and why our approach at FAI is very diﬀerent from others in the industry.
In order to define the FAI approach to diversification it is important to understand many misperceptions of what constitutes diversification. One investor misperception suggests that in order to diversify, one must own diﬀerent geographic regions or diﬀerent business sectors. This doesn’t guarantee diversification as many investments in diﬀerent geographies or sectors are driven by the same economic, political or business variables. For example, most investors would argue that owning stocks in two diﬀerent sectors such as Technology and Consumer Discretionary should help diversify a portfolio. Surely stocks like IBM, Automatic Data Processing, Applied Materials and Citrix Systems shouldn’t act the same way as McDonalds, Target, Carnival Cruise Lines and General Motors. Or should they? Below is the chart of the performance of the Technology and Consumer Discretionary sectors over the last 10 years. As you can see, they are almost 98% correlated over this time frame. Owning stocks in both did not necessarily provide portfolios with any diversification benefits.