Are you satisfied with your diversification?

International Allocation

Diversification is an interesting topic for discussion. There are many theories around what would make a proper diversification but in my case, I have not quite picked a final diversification strategy.

Some questions that go through my gray matter when I think about it:

  • Do you diversify across Canadian, US and international equity?
  • Do you diversify by market capitalization?
  • Do you diversify by investment types?
  • Do you diversify per sectors?
  • Do you diversify within a sector?

As you can see, there are many questions that can be answered to help you diversify. I’ll take them one by one and answer them based on my current situation.

Do you diversify across Canadian, US and international equity?

I have to say that I don’t pay much attention to companies outside Canada and the US. I really don’t have enough knowledge to venture there. I prefer to pick global companies that operate globally, in which case, many of these companies are from the US.

At the moment, 95% of my holdings are in Canada but I plan on increasing my US holdings. I am not sure about the percentage I would be comfortable with though. There is currency conversion that factors in here.

My theory is that if the investments I pick in Canada or the US provide me with the return I want, I don’t need to look elsewhere. This question ranks near the lows for me. I need to invest in what I know and understand.

Do you diversify by market capitalization?

I have not made any conscious decision around setting up my portfolio to have specific holdings in a particular market capitalization but I have to admit that I feel safer with a large cap. That said, the Canadian large-cap are not as large as the US large cap by quite a margin.

Do you diversify by investment types?

This is a very popular question. My investment strategy is around generating passive income so I look at companies with a strong record of paying dividends along with growth. I am mostly investing in equities at the moment. As much as I would like to have cash on hands, I also am focused on accelerating my mortgage payments which usually win the cash. My preference, would be to have cash on hands in order to pick up the bargains when they are around. However, the strategy of holding cash is not really about diversification but more about being able to make a good investment at the appropriate time. I would say that I am pretty focused on equities at the moment.

In my RRSP, due to the scarce number of investment options under the company group RRSP, I have 40% in fixed income. I take my time in evaluating how the funds do and adjust my holdings along the way. The other 60% is currently in Canadian equities. I have avoided the US and international funds because they simply have very poor performance historically.

Do you diversify per sectors?

This is possibly my most important diversification criteria. I pay attention to my weight per sector and this is one of the reasons why the US is interesting to me as it will offer good investments in sectors not well represented in Canada. We all know Canada is strong with financial and energy companies. The telecoms do good but after that, the picking gets slim. I even include the life insurance companies under the financial since they all provide mutual funds and some sort of financial planning.

When I lump the financial institutions together with the life insurance and then put all the gas and oil producers together along with the distributors of energy, that really makes these two sectors really large.

I currently cover the following sectors:

  • Financial (Banking and Life Insurance)
  • Energy (Producers and Distributors)
  • Telecommunications
  • Real-Estate

I am looking at the US to go after some pharmaceutical and consumer companies to broaden my sector diversification. Always with the criteria of dividend growth investment.

Do you diversify within a sector?

This is a question I started asking myself after finding many good companies fitting my investment criteria within a sector. Based on the sector weight, I will allow myself to pick more than one company per sector. In the case of financials, I can look at a bank and a life insurance. In the case of energy, I can look at an oil producer and a distributor. I can look further and pick an oil leader and then a gas leader.

I am also perfectly happy with holding many of the banks. Once my position in one of them is at an acceptable level with respect to my overall portfolio weight, I can look at another one and build a position. I am also comfortable with owning more than one of the telecoms but they are a little riskier as competition is cut-throat and they need to stay competitive by investing and researching. Yet they keep paying healthy dividends.

Final Thoughts …

I have been thinking about diversification to see if having a fixed policy can work with a rebalancing strategy. Over time, as you build a position, can it be advantageous to trim your winner and add to your own holdings? On the other hand, since the market can throw a curve ball at any time, having guidelines is good but you need to be ready to leverage a down market and minimize your impact.

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