What is a diversified portfolio? | John Hanco*ck Investment Management (2024)

The merits of this traditional approach to diversifying were most recently demonstrated in early 2020 when the S&P 500 Index declined nearly 30% over a 30-day period, while the Bloomberg U.S. Aggregate Bond Index only lost around 2%.¹

In other words, if you invested $100 exclusively in large-cap stocks on March 18, 2020, that $100 would’ve bottomed at close to $70, losing almost 30% in value, while a portfolio that included bonds would’ve lost 18.8%—or 13.7% less—than the stock-only portfolio.²The bottom line is that a diversified portfolio may help reduce severe losses—a key objective of many investors looking to protect their overall portfolio.

Alternatives­ are an extremely broad asset class that has historically appealed to institutional investors but that now finds expression in products offered to individual investors. Alternatives may help to deliver performance that’s often uncorrelated to traditional stocks and bonds. Uncorrelated assets aren't expected to perform the same way at the same time, thereby acting as good diversifiers when combined in a portfolio. The broader subset of alternatives may include investments in global real estate, infrastructure, hedge funds, private equity, and commodities such as timber and agriculture.

The extent to which each asset class is used in diversifying portfolios is based on investment objective—such as to achieve growth or generate income—as well as risk profile (conservative, moderate, or aggressive).

Diversifying using non-U.S. assets can help U.S. investors gain access to different sources of investment returns. The case for diversifying by geography is to benefit from the investment opportunities in markets that may have different growth rates, asset classes, dominant sectors, and economic drivers to the home market.

Global markets are commonly divided into three tiers:

• Developed markets, such as the United States, Canada, Japan, Singapore, Western Europe, the United Kingdom, Australia, and New Zealand
• Emerging markets, such as Brazil, China, India, South Africa, and Russia
• Frontier markets, including, but not limited to, several pan-African countries, Thailand, Vietnam, Pakistan, and Panama

Developed markets tend to have lower unemployment, inflation and interest rates than emerging and frontier markets. Historically, they've also had higher GDP, but more recently emerging markets have been contributing an ever greater share of global GDP, making these markets a more permanent feature in investors' considerations.

Source: , World Bank, OECD, John Hanco*ck Investment Management. All data as of 2020, Japan GDP as of 2019.

Emerging and frontier markets offer investors a different set of investment opportunities. Higher interest rates is one positive for global fixed-income investors, while GDP is not only increasing in global share but also generally grows at a faster rate. In the decade before the start of COVID-19, China and India's GDP grew annually by 5.6% and 3.0%, respectively. In contrast, average annual GDP growth in some of the developed markets was much lower, such as in Germany (0.30%), Japan (0.50%), and the United Kingdom (0.80%).³

The aim of diversifying across sectors is to gain exposure to industries that are performing well at a particular point in an economic cycle while maintaining exposure to others that may perform better in the future.

Industries that perform poorly at one point in a cycle could recover rapidly as economic conditions change; for example, discretionary spending in restaurants may drop when an economy is going through a dip, while supermarket spending remains strong as food and other basics are essential items. In a recovery, discretionary spending often rebounds quickly and strongly, so U.S. equity investors with exposure to the consumer discretionary sector from the outset would be best placed to benefit from its early recovery.

Diversifying by investment style gives investors exposure to assets that are grouped by specific common characteristics. While there’s no set definition, growth stocks are generally considered to be the stocks of companies that are anticipated to grow rapidly and therefore generate revenue and earnings at an above-average rate, while valuestocks generally represent well-established firms that often pay high dividend yields and generate steady earnings that are typically slower growing than those of growth stocks.

Investment style also refers to the different approaches portfolio managers may adopt to access specific opportunities. Some managers take an active investing approach, where specific securities are chosen based on in-depth research and analysis; others take a passive investing approach, which typically constitutes investing in stocks that also constitute an index that tracks a set of securities determined by certain rules around market cap, style, and geography.

Both approaches could have merit and specific roles within a portfolio. For some investment opportunities, an active approach may be better, while for others, a lower-cost passive option may be preferable.

Creating a diversified portfolio isn’t always a simple endeavor. When you consider that it involves spreading your investments across multiple asset classes, how you determine the degree of each exposure is the million-dollar question. That’s where a financial professional can play a key role for investors.

A combination of factors, including an investor’s time horizon and investment objectives—capital accumulation, preservation, or income generation—is the key ingredient in determining optimal asset allocation and diversification that align with an individual’s overall risk profile.

1Bloomberg, as of 3/18/20.2Large-cap stocks are represented by the S&P 500 Index, which tracks the performance of 500 of the largest publicly traded companies in the United States. Bonds are represented by the Bloomberg U.S. Aggregate Bond Index, which tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets. It is not possible to invest directly in an index.3GDP per capita growth (annual %) 2009–2019, , World Bank, OECD, John Hanco*ck Investment Management, as of 2021. 4 John Hanco*ck Investment Management, as of 12/31/20. Allocation figures are rounded to the nearest whole number. Allocations less than 5% are not labeled within the charts.