Ancile Capital Management, LLC

Portfolio Construction Technique Analysis: Diversification

5/25/2018

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I am a big believer in using diversification as a tool that I believe can improve the risk adjusted performance of a portfolio.  This concept starts with the proposition that whereas the overall return of a portfolio will equal the sum of the returns of the constituent investments in the portfolio, the volatility of the overall portfolio's returns will be less than the sum of the constituent investments' volatilities if the constituent investments' returns are not perfectly correlated.  If the net return of the constituent investments in a highly diversified portfolio is positive then the volatility should be somewhat dampened and the result should be a smoother ride.

While the traditional 60/40 stock and bond portfolio achieves a level of diversification by including both stocks and bonds together, some commentators, especially Ray Dalio, have made the point that traditional stock and bond portfolios are designed to perform well in environments with low or decreasing inflation.  Harry Browne and Dalio suggest adding gold and other commodities to a stock and bond portfolio to give the portfolio the added ability to perform well in an environment of increasing inflation.

Instead of using just gold or a commodity index to provide this exposure to a portfolio, I aim to achieve a higher level of diversification by adding many individual commodities and currencies.  Thus, individual positions in agriculturals, metals, energies, materials and both developed and emerging market currencies provide my portfolios with exposure to many unique markets driven by their own economic factors. 

​I select my portfolio positions from a universe of more than one hundred separate markets spanning stocks, bonds, currencies, and a range of different physical commodities markets, traded in or representing the economies of many different geographic regions around the world, and typically my portfolios have positions on in three to five dozen markets at any time.  This very high level of diversification should provide the ability for the portfolio to profit in many different unique environments, since combinations of increasing or declining growth and inflation, and other unique economic factors, will be occurring at different rates in different places and have different impacts on different markets.
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    About Neal Stevens

    Neal Stevens is the principal of Ancile Capital Management, LLC, a registered Commodity Trading Advisor and Commodity Pool Operator.  Neal's trading focuses on quantitative, systematic, and long term macro strategies.

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