"A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies." - Harry Markowitz “Diversification is protection against ignorance. It makes little sense if you know what you are doing." - Warren Buffett
Most private client investors will be familiar with the concept of diversification, the nearest thing in investing to a free lunch. Harry Markowitz developed the idea in his paper “Portfolio Selection” in 1952 which became the foundation of Modern Portfolio Theory (‘MPT’). The essence of the concept is that the price of different assets behave differently in response to changing market conditions; that is to say, they are not perfectly correlated.
On average, in a portfolio of diverse assets, the rise and fall in the price of the differing assets will tend to smooth the performance of the portfolio as a whole. As a result the investor can experience less volatility whilst achieving equivalent returns – the free lunch. Despite limitations in the theory, it remains an essential component of many approaches to building portfolios.
In this article, we mix our metaphors and consider whether the same ideas can be applied to selecting investment managers; can the many hands of more than one manager enhance performance through further diversification; or as indicated by Warren Buffett, will the broth be spoilt?