Estably Blog | Value Investing
Diversification:
Does it really protect against risks or does it reduce profits?
Published on 17.07.2024
‘Don’t put all your eggs in one basket!’ is a phrase that persists, especially when it comes to investing. But does broad diversification always make sense? Spreading across different asset classes may have its advantages, but the bottom line is that investors often reduce not only their risk, but above all their return.
The most important facts in brief:
- Merchants were already diversifying in the Middle Ages in order to minimise their risks
- Even supposedly safe ETF investment products harbour the risk of a total loss
- Lack of transparency and counterparty risks are often overlooked in broadly diversified investment products
- Those who value high returns should focus on a few securities and keep an eye on them
Investing as broadly diversified as possible reduces your individual risk in the long term, but unfortunately often also your achievable return. The economy and markets are subject to certain fluctuations and are difficult to predict. However, those who concentrate their investments on a few well-analysed securities and include less volatile asset classes (such as bonds and cash) will fare much better in the long term.
In today’s article, you will therefore find out where the misconception of over-diversification of investments comes from, where its limits lie and how you, as a potential investor, can invest your capital as safely and profitably as possible. We have looked at the following points in detail:
Contents
- 1 What does ‘diversification’ mean?
1.1 Definition, how it works & basic principles
1.2 Historical development of investment diversification
1.3 Modern portfolio theory according to Harry M. Markowitz - 2 Warren Buffett on diversification of investments
- 3. our investment strategy: carefully selected, horizontally diversified securities
3.1 Psychological and emotional aspects
3.2 Importance of analysing companies
3.3 Comparison of returns
3.4 Strategic considerations - 4 Modern Value Strategy: A professional approach to success
4.1 What is ‘value investing’?
4.2 Convincing performance
4.3 Transparent & fair fees - 5 Conclusion: Entrust your investment to a real professional and achieve higher long-term returns
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1 What does ‘diversification’ mean?
Derived from the Middle Latin ‘diversificare’ (meaning ‘to spread’), the term ‘diversification’ in investment refers to the practice of spreading an investment portfolio across different asset classes, assets or markets. This involves spreading investments across different assets, such as shares, bonds, property and cash (as well as other investment products). In many places, ready-made financial products such as investment funds or ETFs are also used. The following sections are dedicated to the definition, functioning and basic principles of diversification, its exciting historical development and modern portfolio theory.
1.1 Definition, mode of operation & basic principles
Diversification in financial investments basically works according to a very simple principle: you don’t just invest your capital in one asset class or investment product, but spread it across several investment opportunities. A distinction must be made between horizontal and vertical diversification:
Horizontal diversification: Here you spread your investments within the same asset class (for example, across different shares or different bonds in order to reduce the specific risk of individual companies or issuers).
Vertical diversification: This type of diversification refers to investing across different asset classes (for example, you could split your money between equities, bonds, property and cash to benefit from the different risk-return profiles of each asset class and reduce the overall risk in the portfolio).
Our personal tip for you:
‘Both horizontal and vertical diversification are critical to an investor’s risk management, but can also lead to undesirable outcomes depending on individual situations and market conditions. Review your diversification strategy regularly to minimise unexpected risks. Dynamically adjust your investments to market changes to optimally protect your portfolio and capitalise on opportunities. Ideally, you should do this with an experienced partner, such as Estably, at your side – so feel free to talk to us!’
Estably Asset Management Ltd
Schaanerstrasse 29
9490 Vaduz
Liechtenstein
Curious about personalised advice and tailor-made strategies for your individual situation? Get your free and non-binding initial consultation with us now!
1.2 Historical development of investment diversification
It has long been accepted wisdom to invest your capital in more than just one idea. Even the merchants of the Hanseatic League in the late Middle Ages spread their risk by using different trading routes and products to minimise risks and counter price fluctuations. In the early modern period, however, when information became generally accessible, this maxim changed. Today, there are numerous examples such as Berkshire Hathaway and concentrated investment funds that can achieve significantly better returns with a focussed strategy. A look at the history of investment diversification makes this clear:
1.3 Modern portfolio theory according to Harry M. Markowitz
Harry M. Markowitz’s modern portfolio theory is a standard instrument for portfolio structuring worldwide. It uses mathematical models to find the ideal balance between return and risk for each portfolio. By selecting assets with low or negative correlations, investors can reduce the likelihood of losses while maximising potential returns (or so the theory goes).
However, this is not always the case in reality! The theory is based on the assumption of efficient markets and rational investors. In practice, however, markets are not always efficient and there are many unpredictable factors that can influence the performance of a portfolio. In addition, the actual correlations and volatilities of assets depend on many factors and can change over time.
„Diversification is for people who don't know what they're doing.“
2 Warren Buffett on diversification of investments
Stock market legend Warren Buffett has been the CEO of the investment company Berkshire Hathaway for almost 60 years now, which has generated an average return of 19.80 % per year. In the same period, the market return was between 8 and 10 % – maximum diversification would therefore have meant a much lower return than Buffett’s relatively concentrated portfolio. The reason for Buffett’s success is that he favours manageable diversification. In his opinion, you should not spread your assets across more than 40 different securities – too much diversification not only reduces the overview, but also the return.
To this end, Warren Buffett selects shares based on fundamental analysis and looks for undervalued companies with a strong business model, consistent earnings growth and competent management. Long-term investments are favoured. The concept of ‘intrinsic value’ is repeatedly applied (a certain margin of safety is also emphasised). Buffett therefore pursues a patient, disciplined and long-term orientated investment strategy.
Our personal tip for you:
‘In the Modern Value strategy, we at Estably also rely on a concentrated approach in which we put together carefully selected investor portfolios that contain a few stocks from different sectors and mix these with low-volatility bonds and cash holdings. In this way, we have been able to generate above-average returns compared to the market as a whole over the past few years. We would be happy to tell you more about our customised portfolios!’
Estably Asset Management AG
Schaanerstrasse 29
9490 Vaduz
Liechtenstein
Curious about personalised advice and tailor-made strategies for your individual situation? Get your free and non-binding initial consultation with us now!
3. Our investment strategy: carefully selected, horizontally diversified securities
Which investment strategy is most suitable overall is always a very individual matter. There isn’t just one successful approach.
Our favourite approach is to invest in a relatively manageable number of individual stocks – from companies that we know inside out. You can find out why this is the case in the following subsections.
3.1 Psychological and emotional aspects
Don’t get us wrong, broad diversification (as we know it from ETFs, for example) is not a bad thing. It is particularly suitable for investors who don’t have the time or resources to take a closer look at different companies and asset classes and want to look after their investments themselves.
‘It is then probably better psychologically and emotionally if you buy the whole market directly instead of trying to pick out individual winning companies on your own.’
But what if you had an experienced and dedicated contact person for your investments? Someone who knows shares and the companies behind them so well, or who can analyse them so well, that they could significantly reduce their risk in this way? With Estably from Liechtenstein, you would have such an expert at your side – he ensures that you can sleep soundly with your investment decisions.
3.2 Importance of the company analysis
Thoroughly analysing the companies in which we invest is an essential part of our investment strategy. Our detailed research enables us to identify the best opportunities while minimising risks. Our team analyses the financial data, market position, business models and future prospects of the companies whose shares we add to our clients’ portfolios. This so-called ‘value’ approach enables us to make well-founded decisions and make targeted investments in undervalued companies that have the potential for above-average price increases.
3.3 Comparison of returns
What average returns can investors actually expect depending on the asset class? We have summarised the most popular investment options and their yields for you (the average yield data has already been reduced by the typical costs and fees):
- Savings book or call money account: between 0.5% and 3%
- Fixed-term deposit account: between 2.5 and 3.8 %
- Securities account with individual shares (typical private investor): between 3% and 4%
- Thematic funds: around 4%
- Passive robo advisors: between 6 and 7 %
- Exchange traded funds (ETFs): around 7%
- Mixed funds: between 7 and 8%
- Hedge funds: around 8 %
By way of comparison: With our in-house ‘Modern Value 100’ strategy, you would have realised an above-average return of around 9% p.a. since 2016.
3.4 Strategic considerations
So how should you ideally proceed? Well, if you are an investor who is not looking for above-average performance, a pure ETF strategy with very broad diversification is certainly a good approach (as it is also cost-effective and harbours a manageable level of risk). However, if you choose the route via a professional asset manager who has all the resources for professional and in-depth company analyses at hand, then the ‘Modern Value’ strategy from Estably is certainly the investment product of your choice. Our ‘Modern Value’ strategy exemplifies the latter approach and has recently delivered very strong returns of around 9% p.a.
Our personal tip for you:
‘For yield-orientated private investors, the concentrated strategy implemented by Estably’s ‘Modern Value’ portfolios is therefore particularly interesting. Through the targeted selection of undervalued companies, supported by the specialist knowledge and expertise of Estably, you give your assets the chance of above-average returns. You don’t have to do practically anything else, because we will be happy to take care of the implementation for you!’
Estably Asset Management Ltd
Schaanerstrasse 29
9490 Vaduz
Liechtenstein
Curious about personalised advice and tailor-made strategies for your individual situation? Get your free and non-binding initial consultation with us now!
4. Modern value strategy: a professional approach to success
So instead of searching for companies with undervalued shares yourself (in line with the ‘value’ approach), we recommend the hand-picked portfolios of the Modern Value Strategy from Estably in Liechtenstein. They offer high-yielding and carefully analysed individual shares and are supplemented (depending on the variant selected) by bond funds and a variable cash component. Find out more about our first-class strategy with strong performance below!
4.1 What is ‘value investing’?
Modern value investing combines traditional methods of analysis with modern approaches in order to recognise the true (intrinsic) value of shares. While Benjamin Graham’s classic value investing approach was based solely on the undervaluation of a company, Graham’s student Warren Buffett and his partner Charlie Munger expanded the strategy to include other influencing factors.
The result was a more modern version of value investing, the basic principles of which we also use to make our investment decisions. In addition to an attractive valuation, the factors taken into account include a high-quality business model, long-term competitive advantages and future growth prospects.
‘Modern value investing aims to achieve very high returns in the long term by focussing on a well thought-out, concentrated approach!’
4.2 Convincing performance
Depending on the individual investment type and investment objective, we recommend a total of five different strategies as part of our Modern Value portfolios. While Modern Value 20, for example, contains 20% equities and 80% bond funds and cash holdings (in euros and foreign currencies), Modern Value 100 consists of 100% individual equities.
The advantage of this is that you vary the risk and fluctuation depending on the portfolio type – the more risk, the greater the potential return. Modern Value 20, which is much less volatile, has already generated a return of 39.59% since its launch in 2016 – Modern Value 100 even achieved 98.37%! The individual portfolios therefore generate an average total return of between 5% and 9% per year!
4.3 Transparent & fair fees
Thanks to our fair and transparent cost and fee structure, you only pay a 1.20 % all-in fee (custodian fees, bank charges, service fees and transaction costs already included) and a performance fee (amounting to 10 % of the profits realised according to the High Water Mark principle).
Our personal tip for you:
‘Save yourself time and nerves with your individual investment and opt for an experienced professional, such as Estably Asset Management from Liechtenstein. You can invest in a large selection of hand-picked shares with us from a minimum investment of just 20,000 euros – make sure you take advantage of this unique opportunity and benefit from above-average performance and a comprehensive service package!’
Estably Asset Management Ltd
Schaanerstrasse 29
9490 Vaduz
Liechtenstein
Curious about personalised advice and tailor-made strategies for your individual situation? Get your free and non-binding initial consultation with us now!
5. conclusion: entrust your investment to a real professional and achieve higher returns in the long term
Diversification can minimise risks, but often also reduces returns. A targeted concentration on well-analysed securities may enable higher returns. However, this should definitely be left to a true professional, such as Estably Asset Management from Liechtenstein. You should therefore focus on a well-considered selection of soundly analysed, undervalued shares. Expanding on a few, well-chosen investments will steer your investments safely through market fluctuations and maximise your profits in the long term. Be bold, but prudent:
‘Those who stay focussed and act professionally achieve more!’
Estably, based in Vaduz in the Principality of Liechtenstein, offers investors not only access to high-quality portfolios, but also to the attractive benefits of a stable and flexible financial centre. Recognised in prestigious publications such as Forbes, Focus Money and wallstreet:online, Estably offers private and institutional investors a wide range of first-class financial services. Not yet an Estably client? We look forward to getting to know you free of charge and without obligation!
Let us advise you on the topics of finance, asset management, capital investment and much more!
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About Estably
Estably is the first digital asset management company from Liechtenstein to offer first-class wealth management through a blend of technology and human investment expertise. Thanks to the portfolio managers’ many years of experience in the field of value investing, the aim is to achieve above-average returns. The aim is to make professional asset management, which was previously exclusively available to major investors, accessible to everyone – conveniently, transparently and profitably.
