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1. Choosing Only One Manager
Savvy investors know they should diversify their portfolios. However, they may not realize that putting all their assets with a single money manager usually will not diversify them adequately.
Most money managers specialize in a single strategy. They might be experts at small, growth stocks, tax-free fixed income, or large, value stocks. Very few managers can be good at more than one strategy. Those few who are often apply their unique selection process to more than one asset class. The manager that can deliver consistently good performance, managing every asset class and style, does not exist.
According to Modern Portfolio Theory, to adequately diversify your portfolio, investments must be spread among different classes of assets whose returns are not highly correlated. This way, when one asset class goes down in price, another does not necessarily follow suit. Different economic conditions favor different asset classes.
As you can see on this chart, illustrating how different Asset Class Returns have performed over time, the same asset class is rarely the top performer more than one year in a row. If you have only one manager, and your manager happens to invest in that asset class – lucky you. However, you would need switch managers every year, and be very lucky indeed to always pick a manager specializing in the top performing asset class next year.
Based on the groundbreaking work of Harry Markowitz and William Sharp, Modern Portfolio Theory asserts that investors should allocate their assets among different classes and match their asset allocation to their tolerance for risk. Risky portfolios get higher average returns, but those returns swing more wildly from year to year than the returns of less risky portfolios. There are years in which they loose a lot of money. Less risky portfolios don’t fluctuate as wildly, but return less on average.
Since money managers concentrate in one, or a few, asset classes or styles, you need a portfolio of several managers to adequately diversify. At WrapManager, before we recommend a manager, we assess your goals in life and your level of comfort with risk. We craft an asset allocation tailored to your goals and risk level. Then we choose from among hundreds of managers available to us and pick the ones best suited to you. We will also sometimes use bonds or exchange traded funds to round out your portfolio.
Investing with only one manager who can not adequately diversify you can be a costly mistake. Don’t just take our word for it. For a deeper understanding, read more about Modern Portfolio Theory.