2009, The Year Of Diversification

Abstract

Today, no company is safe, no industry is secure, no rating is impartial, no advisor is certain, and no country is immune from economic and financial malaise. The days of optimistically believing the advisors and benefiting from investment in equity markets are long gone. Any recommended asset or a strategy is questioned and everywhere doubts outdo trust.  In these financial dark days, however, few things are still true: rational and logical approaches endure, sound and understandable assumptions hold, diversification works.

Diversification is a simple and yet powerful commonsensical approach to investment. It is easy to do and it works well for small and large portfolios with few or many assets. If one chooses to use diversifications techniques, an important question to ask is whether it is based on data across all time-periods, or over primarily down markets when diversification is most valuable. This study examines the performance of a well-diversified portfolio and compares the results with the performance of other portfolios including an equally-weighted equity portfolio over the down market from April 2, 2007 to April 4, 2009.

Although there still exits a sense of uneasiness in the stock market about equity investing, the above average rate of returns and steady growth of diversified portfolios over the past two troubling years compels investors to consider diversifications again. The main goal of this work is to first examine the performance of several companies and compare their risk-adjusted returns to the returns of indexes, mainly S&P 500, and then compare the performance of a well-diversified portfolio with a balanced equity portfolio. Specifically, this study is going to address whether the performance of a well-diversified portfolio meets or surpasses the performance of a diversified equally weighted portfolio. More importantly the emphasis of this work is to determine whether diversification consistently and significantly contributes positively to the performance of the US equity portfolios.  The asset selection and the optimization process applied to portfolios are identical to maintain consistency and comparability of the results. For each portfolio we used the 2005-2007 daily observations to optimize allocations and we used the 2007-2009 data to evaluate the performance of each portfolio.