Alpha Pointe Capital

Diversification vs. Worsification Part 1

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On Pointe – Wealth Management Edition

Diversification vs. Worsification Part 1

Everyone has heard or at least has been told about diversification. “Don’t put all of your eggs in one basket” is the refrain for spreading your risk within the portfolio. However, here at Alpha Pointe Capital, we see a very different picture of diversification. We’re seeing “worsification.”

Let me start with a story…

I was in Denver, CO. visiting with one of the many new space contractors. These “Space” contractors are finding numerous US government contracts for almost anything to do with space. NASA is putting out RFPs for satellites, geo-navigation, and many other fascinating projects. What am I doing in space? Space just happens to be another emerging industry in need of our services!

Back to my space contractor friend… He says his problem is his portfolio. When the markets rise, he doesn’t see any improvement in the value of his portfolio. Another problem is his statements are 25+ pages deep and he can’t tell what he has and what is working.

So, he called up his advisor because he was interested in purchasing a popular stock in the AI sector. He thought this might “spice” things up a bit.

Fast forward a couple of days when the advisor got back to him. The advisor explained to him that he already owned the stock in 5 mutual funds. In addition, he had exposure to that very same stock in 6 ETFs (exchange-traded funds).

Hmm… Then the space contractor asked the most logical question, “Then why won’t my portfolio move higher when this stock moves higher?”

And then he dropped this bomb, “Why do I need so many mutual funds and ETFs that overlap with the same investments?”

As you can see dear reader, there are a couple of things that really need to be sorted out to understand this trend of worsification.

So, let’s define it first… “Diversification is a risk management technique that involves spreading your investments across different assets in order to reduce the overall risk in your portfolio. The idea is that, even if some of your investments lose value, others may gain value or hold steady, helping to cushion the impact of potential losses.” Morningstar – Diversification

The advisors at Alpha Pointe Capital generally agree with this definition. But you may choose the view of “opportunity” risk. Whereby a portfolio is so over-diversified it may not benefit from positive trending securities.

Or the poor-performing assets drag on the better-performing securities. Thus, diminishing the potential opportunity.

Almost like a double-edged sword…

Our client’s portfolios are diversified, and they may have a couple of ETFs, but there is a difference. We’re diversified into the strength, whereby we may outweigh stocks and sectors of positive trending securities.

What this means is we’re being intentional about overweighting because we view the potential for rising prices. We will often carry less than 25 securities for the equity portion of the portfolio and rarely use mutual funds. The reason is we are intentionally targeting certain areas for growth and intentionally leaving out those areas that simply keep falling.

We also prefer to have fewer securities, so we are nimble enough to rotate in and out of securities and sectors. We also know exactly what is in our portfolios… there is transparency and intentionality in our portfolio construction to position our clients appropriately. This allows for more timely, active management… not to mention it’s easier to communicate with clients.

Look at your statements… how many mutual funds/ETFs/SMAs do you have? How many pages of securities do you have for your equities? Think about whether you’re diversified or “worsified” and how this may affect your retirement goals.

Take care,

James S. Gibbons CPFA
Alpha Pointe Capital-Founder/Wealth Manager

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