Diversification is often referred to as the only free lunch in investing. Marina Gross, executive vice president at Natixis Global Asset Management, said spreading out your assets is now more important than ever due to years of central bank experimentation.
"In the past several years, markets haven't behaved normally because of monetary policy. Correlation among asset groups increased, so diversification didn't pay off like it should have," said Gross. "Recently, however, the most diversified financial advisors have been the most successful."
According to Gross, advisor portfolios with the highest level of diversification have had the best return over the last year -- with 7% -- compared with the 2.6% return of the least diversified, over a period marked by three major market selloffs. Although portfolios have become more diversified, on average they still contain about 60% equities, and that 60% is driving 93% of the portfolios' risk.
"Investors need to understand their risk and make sure they are truly diversifying to get all of the benefits," added Gross.
Meanwhile, alternatives are working. In the last three years, portfolios analyzed by Gross' team have doubled their allocation to alternative assets and diversified the number and types of alternatives they use. Portfolios with 10% or more in alternatives have higher risk-adjusted returns than others in the last four years.
"We expect the trend of alternatives use to continue," said Gross. "Choosing the right strategy and using them in the right proportions is important."
She also points out that alternative indexing is on the rise. For investors who prefer to use passive strategies, alternative indexing and enhanced indexing help diversify within stocks. The strategy is used in 52% of advisor portfolios compared with 25% four years ago. And so-called smart beta accounts for about half of the "passive" allocation in the portfolios they analyzed.