A Harvard Professor Says Diversify Better

Harvard Professor Andrew Lo has been in the media of late, including a recent interview on the Wealthtrack program with Consuelo Mack. The conversation is about 25 minutes long (including lead-in stuff), so you'll need to allow for sufficient space in your busy schedule to fit it in. There are some interesting aspects to what he talks about and what he's doing in his money management business.

In the conversation, Lo talks a lot about diversification and introduces the term "diversification deficit disorder". He uses that to describe the current situation where the high correlation between the major investment markets (primarily stocks and bonds) has created an environment where putting together a diversified portfolio is much more challenging.

None of this is really new, of course. Financial planners and market professionals have been talking about this for some time now. Lo suggest that we need to be expanding into alternative investments like commodities and foreign exchange. Again, nothing new there. The bigger point he makes, however, is that investors need to be much more active in their investment management these days. He doesn't mean turning into day traders, but rather being much more aware of what's going on with our investments, and in particular with our portfolio volatility (and thereby risk) levels.

The one aspect of diversification that Lo doesn't talk about is what I like to refer to as "diversification of approach" or "diversification of management". By that I mean investing in people and/or operations which can generate returns for you with little correlation to the returns generated by more standard investments – even more alternative investments. You're not investing in a market or asset class, but rather the skills of a manager or firm. In many ways, this is the core of hedge fund investing.

The Currensee Trade Leaders program is this sort of diversification. Yes, its focus is on foreign exchange, but that's as far as things go in terms of creating a currency market allocation. I documented this in the post Trade Leader Non-Correlations to the Markets. The numbers there show that taken as a whole, the Trade Leaders were only about 24% (negatively) correlated to the US Dollar Index and basically not correlated at all with the other major asset classes. If the Trade Leaders were just investing in currencies, we'd see much higher correlations. Instead, we have a diversified non-buy-and-hold methodology that's offering up considerable diversification opportunities for investors.

And to Professor Lo's point about paying close attention to risk, one of the primary statistics Currensee presents for each Trade Leader is their volatility. This is important information you should have for any investment you're considering.

 

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