LIVE MARKETS-Diversification may not be all it's cracked up to be

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DIVERSIFICATION MAY NOT BE ALL IT'S CRACKED UP TO BE

Diversification is often regarded as a pillar of sound investing. It's widely believed to reduce risk, smooth out returns, and provide stability in uncertain markets.

However, Kevin Caron, senior portfolio manager at Washington Crossing Advisors, believes this assumption warrants a closer look, especially when considering the realities of bear markets.

"Many will assume that the best way to handle risk is to diversify. The logic seems simple: by spreading investments across different sectors, asset classes, and geographies, losses in one area will be offset by gains in another," writes Caron in a note.

However, according to Caron, diversification can unintentionally introduce unwanted risks and distract from attaining specific goals.

He notes that excessive diversification can water down exposure to high-quality investments, reduce a portfolio’s ability to withstand bear markets, and introduce unrecognized risks.

For these reasons, Caron believes concentration in high-quality investments is a more effective strategy because, he says, "investing success does not come from owning more stocks—it comes from owning the right stocks."

As Caron sees it, high-quality businesses tend to demonstrate lower debt levels, higher profitability, and more reliable earnings and dividends. It's these characteristics that make them resilient in bear markets.

To use a sports analogy, Caron says that a championship team is built by concentrating on elite players, not by ensuring an “even mix” of skill levels across the roster.

Indeed, Caron's view is that "a portfolio that prioritizes diversification over quality will inevitably hold underperforming stocks that drag down returns—especially in bear markets."

(Terence Gabriel)

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