How to diversify a portfolio: 3 ideas for 2015

2015 has already proven to be interesting for equity investors. Chances are non-U.S. investors have likely done well in U.S. equities over the past five years. And certainly, you can’t blame U.S. investors for sticking with stocks close to home. They’re familiar, and they’ve made money for many people. In fact, my colleague Jaylene Howard details the “home country bias” that U.S. investors have in a recent post for financial advisors.

Diversification investment ideas

However, these days most equity investors, regardless of their location, are probably over-allocated to U.S. equities. That means they may be missing out on what I see as three areas for investment opportunity to diversify their portfolios:

  1. Non-U.S. risk assets: Over the past five years, U.S. stocks have generally risen nearly 15% annualized. Outside of the U.S., stocks have mostly risen a bit over 5%.1 Combined with the strength of the U.S. dollar against essentially every global currency, that means there are likely tremendous bargains to be had overseas. Moreover, even as the U.S. Federal Reserve has ended quantitative easing and now is on the verge of hiking interest rates, central banks in both Japan and Europe are continuing on a QE adventure while keeping rates low. That puts a lot of potential wind in the sails of stocks within the economies of Japan and Europe.
  2. Credit: Yields on government bonds remain low across the board – hovering near zero or even below that in Europe.2 But there are opportunities to be found in U.S. corporate credit. Although rates are fairly low now, we anticipate non-U.S. investors increasingly coming into the market, bidding up corporate credit prices and lowering yields. Simultaneously, the continued strength of the U.S. economy makes betting on corporate credit in the U.S. a potentially wise proposition, given the inherent risks of investing, with limited defaults and credit downgrades.
  3. Emerging markets: OK, this is a bit of a tougher call. But for those willing to tighten their seat belts and get in for the long haul, emerging markets have potentially good upside. True, a rate hike in the U.S. could cause some problems in emerging economies, but we think the risks are modest and already are being priced into the market. Also, pessimism about emerging markets – look at the problems even in relatively sophisticated Brazil – is high these days. So we’re taking a contrarian view by saying that some may want to consider prudent exposure to these riskier markets. 

A last word on investment portfolios

During the past five years markets generally have risen relatively in parallel around the globe3. But now, as central banks take different approaches, things are more apt to change rapidly and head in different directions from continent to continent. That means a “set-and-forget” investment approach – while often a mainstay approach in the past – may not be the best option for most investors. My colleague David Vickers touched on this need for careful curation and regular attention to a portfolio a few weeks ago in his post.

We believe that considering a more actively managed approach for an investment portfolio that allows an investor to respond more opportunistically to market swings, wherever they may occur, is particularly wise at this time. In the current market, it appears active managers will have a welcome chance to prove their worth.

1 Russell 1000® for U.S. and the Russell Global ex-U.S. Large Cap Index, both ending March 30, 2015.
2 Bloomberg, March 30, 2015.
3 Russell Global Indexes®, as of February 28, 2015 – 5 year return of 11.63%