“Diversification the only free lunch in finance,” Harry Markowitz, pioneer of modern portfolio theory and Nobel Laureate in 1990.
“Diversification is a protection against ignorance,” Warren Buffet, the Oracle of Omaha.
Whom to believe?
Before choosing sides, let’s see how diversification has affected equity market investments so far in 2024.
The Russell 2000 is an equity index composed of the stocks of 2000 companies. Year to date, it is down 1%. The Dow Jones Industrials Index of 30 companies is up 1%. The S&P 500 and Nasdaq 100 are up 12% and 14% respectively. One of the key drivers for their outperformance is that both indexes include high-flying AI chip maker Nvdia (pronounced En-vidia, in case you were curious) which is up 166% and today constitutes 7% of the S&P and 8.5% of the Nasdaq.
A back-of-the-envelope calculation is that without Nvdia, the S&P and Nasdaq would only be up half of their 2024 gain.
Was your portfolio diversified enough to include Nvdia?
Let’s go back to Buffet, and examine the totality of his comment about the role of diversification.
“You know, we think diversification is—as practiced generally—makes very little sense for anyone that knows what they’re doing. It is a protection against ignorance.”
Buffet is diversified in that Berkshire Hathaway owns approximately 50 companies, but 40% of the portfolio is in the stock of Apple. Buffet knows what he is doing and can concentrate. In fact, Apple is up 11% year to date in 2024.
Let´s face it, you are probably not Warren Buffet. Unless you can devote yourself full-time to studying companies, industries, and macroeconomics, diversification continues to be important. Markowitz is right - diversification is a free lunch, until of course, it isn’t.
When a crisis hits, the value of diversification goes out the window, as players sell anything and everything to raise cash.
That crisis does not seem imminent, and this week’s Macro Monitor is flashing green, or “risk-on.” It was also green last week, as the model has captured the momentum provided by the AI stocks like Nvdia.
Disclaimer: The content of this post reflects only the views of the author and not necessarily those of Armor Capital.