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Should You Only Hold Stocks in a Portfolio?

Traders Magazine Online News, April 12, 2018

John D'Antona Jr.

Are stocks the best bet in oneís portfolio?

Or is diversification among the myriad asset classes the way to go?

A new white paper by Ampersand Portfolio Solutions, The Risk Contribution of Stocks, puts a spotlight on the risk contribution of stocks in a portfolio and urges investors to diversify into other asset classes. Ampersand Portfolio Solutions, a division of Equinox, collaborates with select asset managers to construct bespoke investment solutions.

Most investors, both individual and institutional, believe that stocks are a good, perhaps even the best, investment in the long run. However, the reason for expecting good performance from stocks is not always fully understood: Quite simply, it is because they are risky.

Ampersandís white paper, makes the case and illustrates the riskiness of stocks; a value that escalates when volatility increases. While most investors believe that a 60/40 stock/bond portfolio is well diversified, they are mistaken.

WTF? But thatís what I was taught in business school. †

Ampersand analyzed the volatility of stocks and bonds over a 41-year period (1975-2016) and constructed a 60/40 stock/bond portfolio and found that the risk contribution of stocks is a whopping 92%.† An 80/20 stock/bond portfolio is even riskier, with stocks accounting for 98% of the risk. In a 40/60 stock/bond portfolio, 76% of the risk still comes from stocks, and even a portfolio with as little as 20% allocated to stocks derives almost 40% of its risk from stocks. Nonetheless investors continue to hold significant positions in stocks because of the expected higher returns.

How does diversification beyond bonds and into other non-correlated investments affect the risk and returns of a portfolio? Ampersand added another asset class, managed futures, to the stock/bond mix to examine the diversification benefits. Using a series of illustrative charts, the power of diversification comes into clear focus.

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