Diversify your portfolio, but don’t dilute it

Diversification is the 2020 buzzword for investors searching for a safe port to ride out the Covid-19 pandemic’s economic storm. Fenestra Asset Management CEO and founder William Meyer says it’s a needless sacrifice to dilute a portfolio’s well-performing assets for safe havens and is just a guarantee for lower returns. Diversification has its benefits, but also its pitfalls.

Meyer has, over the decades, trawled through countless institutional investor portfolios for prospective clients “to check that they are not overdiversified”.

The insight afforded to these portfolios over the years has starkly revealed the cultural divide between the one-size-fits-all institutional investor manager’s mindset and Fenestra’s nimble and nuanced approach to growing a portfolio, even during times of adversity.

Founded in 1992, the boutique investment company’s cherry- picking from “a small universe of local and international companies” allowed Fenestra clients to skirt the catastrophic losses of African Bank, Brait, EOH, Steinhoff and Tongaat Hulett after refusing to offer them in portfolios.

Institutional managers’ standard template for their clients, Meyer says, is in-house unit trusts, some stocks, bonds, ETFs and cash. This methodology has earned the disdain of Warren Buffett, the world’s investment philosophy guru, who said “diversification is for people who don’t know what they are doing”.

“Drilling down into these funds, you find that they are actually indirectly invested into hundreds of companies,” Meyer says. “Sometimes easily more than 500 different counters.”

The smoke and mirrors of institutional managers’ practice of thinly spreading investments dilutes the worth of its top 10 holdings’ weighting to less than 2%. This translates to the portfolio manager’s top picks representing less than 0.2% each.

The low percentage of institutional managers’ top stocks “is not going to move the needle even if these top picks perform exceptionally”, Meyer says.

The top equity picks for a portfolio should, at the very least, be weighted at 5%, Meyer says.

“If these stocks do well, and they should if carefully researched and bought with high conviction, they will result in a serious outperformance for the portfolio,” he says. 

“On the other hand, the seriously and terminally overdiversified portfolios can never mathematically outperform the benchmark because they are, in effect, the entire market. These are the closet index funds masquerading as managed portfolios carrying layer upon layer of expensive fees that nibble away at performance.”

The slew of opaque charges and fees on investments is one of the fundamental reasons institutional clients have such a stressful experience, Meyer says. The other is the “firewall” of call centres, computer conversations and “robo advice”, resulting in clients not understanding their own investments.

Personal relations between a manager and client is the cornerstone for successful investments.

Fenestra is fiercely uncompromising in its independence, which allows an objective local and international view gleaned from decades of investment experience and an intimate market knowledge.

The ambition is more tactile, Meyer says: “We identify  our client’s needs and then design individual and specific portfolios to make this person’s life better, simpler, less stressful and more comfortable.”

Any acceptance of the 2020 economic doldrums is not found in the lexicon of the asset management company that has consistently outperformed the markets through both bull and bear runs.

The scattergun approach to diversification guarantees disappointment, Meyer says.

“But can you enjoy great benefits from diversification? The answer is an unequivocal yes,” says Meyer. “More than 90% of a portfolio’s return stems from the capital allocation decision.” 

He uses the parameters of the extremes for illustration.

“Allocating all the capital to short-term money market cash accounts, the after-tax, real and adjusted-for-inflation return is guaranteed to be very low. The prevailing return on Swiss francs is -1%. An investment of Sf100 would translate into Sf99 in a year,” he says.

“At the other end of the scale, identifying and allocating all the capital to the ‘next Apple’ would result in ‘stupendous’ returns. However, the sweet spot is somewhere in between.”

The preservation of capital is the linchpin of a balanced Fenestra portfolio that allocates capital to safe haven assets such as gold, the US dollar and other hard currencies, while counterbalancing the portfolio with well-performing equity components.

Meyer says that equities carry the entire portfolio as the return on the safe haven investments will be very low.

“Some clients are horrified by the safe haven investments as they don’t provide much return, but these are the lifeblood of the portfolio because they can fund the opportunistic and high-conviction purchase of equities,” says Meyer.

“In a sense, their relatively low return now will provide the greatest return as they are converted into special stocks and evolving portfolios always have cash on hand for future growth.” 

This article was paid for by Fenestra.