Issue link: https://mbozikis.ufcontent.com/i/1488214
For some investors, these results lack the appeal of high-flying tech stocks, rapidly rising emerging markets or other flavor-of-the month champions. Because diversification can be challenging for investors to understand, we developed a framework that demonstrates its power using these three highly simplified investment strategies: Return Chaser Strategy: Invests in the top-performing asset class of the prior year Contrarian Strategy: Invests in the worst-performing asset class of the prior year Diversified Strategy: Invests equally across a wide range of asset classes We found that over the last 10 years, the contrarian strategy was the top performer 50% of the time, and the return chaser strategy won 40% of the time. Meanwhile, the diversified strategy came out on top only once during those 10 years. Annual returns from 2010 (to establish best- and worst-performing asset classes going into 2011) through 2020. At the start of each year, the hypothetical Return Chaser strategy invests 100% in the best-performing asset class of the prior year (U.S. Large Cap in 2020), the hypothetical Contrarian strategy invests 100% in the worst-performing asset class of the prior year (Cash in 2020), and the hypothetical naïve or 1/N Diversifier strategy invests equally in all asset classes. Asset-class proxy indexes: US Large = Russell 1000, US Small = Russell 2000, Int'l Equity = MSCI EAFE, EM Equity = MSCI Emerging Markets, Core Fixed = Bloomberg Barclays Aggregate Index, High Yield = Bloomberg Barclays US Corporate High Yield Total Return Index, EM Debt = 50% JP Morgan EMBI Global Diversified/50% JP Morgan GBI EM Global Diversified, TIPS = Bloomberg Barclays 1-5 Year US TIPS Index, Commodities = Bloomberg Commodity Index, Long Duration = Bloomberg Barclays US Long Government/Credit Index, Short-Duration = ICE BofAML 1-3 Year US Treasury Index, Cash = ICE BofAML USD 3-Month Deposit Offered Rate Constant Maturity Index. Sources: Index providers, SEI. Past performance is not a guarantee of future results. FIGURE 2 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 ■ Return Chaser ■ Contrarian ■ Diversifier RETURNS Contrarian Contrarian Contrarian Return Chaser Return Chaser Contrarian Diversifier Return Chaser 2 0 1 9 2 0 2 0 Return Chaser 8.8% 4.9% -3.3% 1.1% 14.6% 2.6% 17.8% 0.3% 18.2% - -9.5% 11.8% 1.1% 1.5% 18.4% 1.1% 0.0% 9.6% 5.7% 1.9% -4.8% 8.2% 11.4% 14.4% 8.8% -30.0% -25.0% -20.0% -15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Contrarian -17.0% -2.6% -4.2% -24.7% -5.3% -14.6% … but diversification also rarely loses, and has won over time We've already established that a diversified strategy won't necessarily beat the top-performing asset class in a given year. But, by definition, it can't be the worst performer either. In terms of risk-adjusted returns—despite rarely beating the two other strategies in a single year—the diversified approach has won hands down over the past 10 years. In Figure 3, the diversified approach would have provided a respectable overall gain with less volatility, resulting in much higher risk-adjusted returns. This is despite the diversified strategy being the top performer only once during the 10-year period.