When is 3 Really 1 ?

A new client asked us to review three funds that he had been holding for a very long time in a retirement account.  Each of these funds were managed by the same mutual fund company, but had distinctly different names.

Upon my review, the results were not surprising to me, but startling to the client. Each of these funds were basically holding the same stocks. So while the client thought they were broadly diversified, based on the names of the different funds, the tops holdings read like three interchangeable and almost identical lists. We actually held the three top holdings lists side by side, and they looked almost the same.  Each had many of the same companies like Apple, Exxon Mobil, IBM, GE. You get the idea.

There was no effective diversification at all, if you think about effective diversification as we do. There were no small companies, there were no real estate companies, there were no small value companies. There was minimal international holdings, which is a serious problem, in our view. There were no emerging market stocks.

So while the client had 3 funds, they really just had 1 fund, with 3 different names. They had not achieved the diversification they thought they had, and knew that was in their best interest.

Separate from this client example, the current year's worldwide stock market performance, as viewed by asset class, provides great evidence of why "effective diversification" across many asset classes is so important. A sample of some asset classes, as evidenced by DFA mutual funds for YTD through 11/30/10, makes the point:

US Large, which is similar to the S & P 500:                     +  7.8%
US Micro Cap (very small companies)                                +21.3%
US Real Estate                                                                 +22.9%
International Small Company                                             +11.8%
Emerging Markets Value                                                   +12.7%

Please note that the above is presented only for illustrative purposes, for an 11 month period of time, and before any advisor fees.

However, the point remains, many people have a portfolio which may hold many mutual funds or individual stocks, but if reviewed carefully, basically acts or is very similar to the S & P 500.

That is not in your best interest, over the long run, for a successful investment experience.