Is your portfolio truly diversified?

Is your portfolio truly diversified?

Understand investment holdings to manage risk, stabilize returns


Have you noticed? Stock markets have been climbing to new highs through the summer. And the growth stock sector continues to be expensive. Value stocks, holding true to their name, generally are not. In fact, according to Yardeni Research, the valuation gap between growth and value stocks hasn’t been this wide since 2000. Then there’s bonds. Canadian inflation was posted at an annual 3.7% in July and 5.4% in the U.S. Government of Canada 10-year bonds were yielding 1.26% in August, for a before-tax negative real return of 2.4% if inflation turns out not to be “transitory.” Diversifying your portfolio can help manage these vagaries of the market. But how can you tell if your portfolio is in fact properly diversified?

Let’s say you decided to be prudent and diversify away from high-flying growth stocks over the past year or so, and bought into the BMO MSCI Canada Value Index ETF. And suppose you were also advised to add a broad equity fund like the Fidelity True North Fund Series A. Both are good performers in themselves. But have you really diversified?

A properly diversified portfolio will maximize profits and minimize risk. When you purchase a mutual fund or exchange-traded fund, you are buying a share of a pool that is invested in specific assets that might include Treasury bills, stocks, and bonds in a variety of sectors and countries. For asset allocation purposes, funds can be broadly segregated into the main asset groups: safety; income; and growth. But for portfolio management purposes, funds are categorized by a far more detailed classification system. One of the most widely-used systems is established and monitored by the Canadian Investment Funds Standards Committee, and is used in Fund Library.

Similar fund holdings can skew your portfolio risk

Both funds mentioned above have decent track records. But both are categorized as Canadian Equity, and each has good internal diversification in the Canadian equity market. Nothing wrong with that in itself. Drilling down into the funds’ holdings tells a different story, however. If you holds both these funds in equal measure in your portfolio, you are in fact doubling your holdings of certain stocks that are found common to the top 10 holdings of each fund.

As of July 30, the top 10 holdings of both of these included CGI Group, Toronto-Dominion Bank, Bank of Nova Scotia, and Royal Bank of Canada in their top 10. Nearly half of the funds’ top holdings were duplicated. As a result, you end up having way too much exposure to just a small handful of stocks. And whether the fund has a “growth” orientation or a “value” slant, that kind of exposure increases your risk profile considerably.

You might think you are doing the right thing by adding a couple of broad fixed-income funds to diversify your portfolio by asset class. But the same challenge will apply to fixed-income as well. Are you in fact holding too much of the same types of bonds in apparently different funds? And are these bonds subject to the kind of interest rate risk that results in negative real returns, or falling prices if rates should start rising in the event that inflation isn’t “transitory.”

As a risk reduction tool, asset diversification makes a lot of sense. If you are inadvertently under-diversified, as in this case, you have concentrated too much capital in one area, and you may be doing more harm than good. Not only are you paying twice for the same holdings (through the funds’ MERs), but you also expose your portfolio to greater downside risk, because of course, if these stocks decline in one fund, they’ll see precisely the same decline in the other.

Investment holdings review

If you find yourself in this situation, my suggestion is to review your investment objectives and risk tolerance to determine an appropriate asset allocation – in other words, first decide how much you want to commit to the broad categories of safety, income, and growth. Once you’ve completed this step, you can begin to select the funds that meet your desired outcome.

To avoid falling into the under-diversification trap, compare the holdings of each fund in your portfolio and assess their suitability in your desired allocation and risk targets. If you find you’ve got too much concentration in one area, consider searching for funds in other categories with holdings that aren’t as closely correlated.

The Fund Library has some powerful filters and screening tools to help you get started. But be careful not to go to the other extreme of over-diversification, which can increase costs, monitoring time, and ultimately dilute overall portfolio returns. Limit your fund holdings to between six and 10 funds.

If you are not clear about the ins and outs of portfolio diversification by asset class, by geographic exposure, by sector, and by individiual holdings, consult a qualified, independent, fee-only financial advisor (that is, one who is not captive of a single fund company or financial institution).

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at for a confidential planning consultation.

Notes and Disclaimer

© 2021 by the Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.